Finding value in infrastructure investment
Competition for infrastructure assets is presenting a challenge for SMSF investors looking to find value in this asset class.
During the past five years, we’ve seen a significant rise of infrastructure as an asset class. This has been underpinned by three key demand factors:
- Search for yield;
- Large capital inflows;
- Increased investor awareness.
Search for yield
Since the global financial crisis, interest rates in many developed economies including the US, UK and Australia have been at historical lows. This phenomenon has led to the ‘search for yield’ whereby investors who may have historically relied on particular asset classes for sustainable long-term sources of income – such as bonds – have begun to look for alternatives that will meet their income needs. As unlisted infrastructure assets typically provide long-term, stable cash flows with yields higher than bonds, it has become one of the prime beneficiaries of this search for yield.
Large capital inflows
With the growing maturity of pension schemes across the world, pension funds are receiving an increasing amount of funds to manage. This trend has contributed to institutional investors increasing participation in alternative investment markets.
According to the 2015 Preqin Sovereign Wealth Fund Review, total assets of sovereign wealth funds have doubled to US$6.31 trillion since 2008. As sovereign wealth funds are long-term investors with large amounts of discretionary capital, they are able to take large stakes in relatively illiquid investments. This makes infrastructure investments ideal for sovereign wealth funds.
Increased investor awareness
Investors have come to understand the many benefits that unlisted core infrastructure provides to a portfolio; such benefits include low volatility, high yield, gross domestic product and inflation linkage, and low correlation with equities. The enhanced understanding of the benefits that infrastructure brings to an investment portfolio has increased appetite for such assets.
Greater competition, higher prices
The increased appetite for infrastructure has led to increased competition for infrastructure assets and, as a result, increased asset prices. The competition for assets has been compounded by strategic investors who bring sizeable synergies and often lower return hurdles to the table.
Examples of this include the sale of the Queensland Curtis LNG pipeline, which links world leading LNG BG Groups natural gas fields in Southern Queensland to an export facility on Australia’s east coast; the acquisition of Queensland Motorways (Queensland Motorways at a multiple of circa 27 times EBITDA) and more recently the acquisition of Port of Darwin by the Chinese owned Landbridge Group.
It is important to note that the current low interest rate environment may have additional downside impacts on infrastructure investment. Against a competitive back drop, infrastructure investors will be increasingly challenged in finding opportunities and in achieving suitable risk-weighted returns as competitive pressure continues to compress required returns and increase investor risk exposure.
In the face of the increasingly competitive market for infrastructure, it is clear that investment managers should not rely on winning ‘cost of capital shoot-outs’ in which they pay the highest price simply by lowering their required returns below those of their competitors. Equally, investment managers should not rely on bidding a more aggressive business case to secure such opportunities without pricing additional risks in to the required returns. Adopting such a bid strategy simply heightens the risk to the downside for the investors.
There is argument in the current market that improved risk-adjusted returns can be achieved in thematic infrastructure in the mid-market space. This is because there is relatively less capital seeking such investments and consequently less competitive pressures on returns and business case assumptions.
Thematic infrastructure holds common infrastructure characteristics such as inflation protection, high barriers to entry and long-term sustainable cash flows but typically has a higher level of complexity that requires active management. Examples of such complexities include higher operational leverage and more complex market dynamics. Lower overall competition in this market means investors can secure such investments without compromising their risk return profile, bidding appropriate risk-adjusted returns and business case assumptions.
With current market conditions resulting in intense competition for infrastructure, thematic infrastructure can offer a more attractive risk-adjusted return. However, it is important to note that these assets may have exposure to operational and market risks which need to managed accordingly.
About the author
With more than 20 years experience in the industry throughout Sydney, Singapore, Amsterdam, New York and London, Boe Pahari has led the creation and development of principal, advisory and banking businesses across a number of prominent financial institutions.