From calls for new airport runways to superfast broadband for sleepy villages, demand is rising for improved infrastructure. With City fund managers like Neil Woodford pumping £10m into Gigaclear, a small broadband provider, hoping to bring internet coverage to remote parts of the UK, there are signs that institutional investors are willing to back new projects.
With increasing strains on the public purse, business leaders worldwide are are pushing for pension funds and insurance companies to shoulder more of the cost and provide the funds to replace and rebuild creaking infrastructure.
This week, the global research group and think-tank, the Official Monetary and Financial Institutions Forum urged governments to intensify privatisation of brownfield assets – projects already built – and utilities to finance new infrastructure developments.
Private groups are starting to rise to this challenge. Since January, more than $25bn has been issued for infrastructure assets on equity markets according to data from Thomson Reuters — double the amount issued three years ago — as investors search for higher yields that have been financially repressed in bonds.
Several significant global deals struck during the past week have involved the large pensions groups. CPPIB joined forces with Singapore’s sovereign wealth fund to acquire a South Korean shopping mall for $263m, while Calpers, the largest US pension fund, pledged $1bn for infrastructure projects in Australia and Asia.
“Infrastructure has become more popular with investors as it is a strong yielding asset class in a low-yielding world,” says Cressida Hogg, head of infrastructure at Canada’s biggest pension fund CPPIB.
Infrastructure assets provide a fixed stream of bond-like, inflation-linked returns which is ideal for pension funds as it helps them match their liabilities of paying their retirees, says Andrew Claerhout, head of infrastructure at Canada’s Ontario Teachers’ Pension Plan.
Yields on assets can range from 2 per cent for ultra-safe utilities to 20 per cent for risky emerging-market projects. At a time when $2tn of bonds are trading at negative rates, these yields have become even more appealing.
Infrastructure is one of the most important areas for business. But we need more private investment as the taxpayer can no longer afford to pay for these services
However, both Ms Hogg and Mr Claerhout warn there are risks: investments in planes, trains and automobiles have suffered setbacks. Heathrow airport, the Channel tunnel rail link and some high-profile toll road projects in the US and UK have all at one time run into problems.
Martin Lennon, head of M&G’s infrastructure equity arm Infracapital, which invested alongside Mr Woodford in Gigaclear, cautions that investors “have to distinguish between different types of infrastructure assets, from those considered safer, such as core utilities, and those that are more cyclical, such as airports and roads”.
Assessing political risk is also key. “Will a government introduce regulations or laws that will hurt the business, or in the extreme will they simply look to take control of the business and nationalise it?” says Mr Lennon.
One of the main distinctions is between brownfield and greenfield investments. A brownfield investment is in an established company, such as a utility that will offer inflation proofed returns from its stable cash flows.
In contrast, a greenfield development has not been built, which means it has construction risks and no cash flows, usually for the first three years while it is in the construction or development phase. These can in the long run prove to be the most profitable, with yields in the mid-teens.
Investing in projects which have not yet been developed can be a gamble. One of the most notorious failures was the Dulles toll road in the US during the 1990s where all the equity had to be written off because drivers preferred to use the alternative free route. The UK’s Birmingham relief road met with a similar fate.
Cyclical businesses and high amounts of leverage can be another pitfall for investors looking for a stable stream of cash flows. Passenger numbers and profits at the former British airport authority, BAA, now Heathrow Airport Holdings, suffered badly during the 2008 downturn, while Australian investment group Babcock & Brown was placed into liquidation as it took on too much debt.
Although past failures have deterred some investors, new infrastructure funds came on to the market last year with an average size of $1bn, compared with $683m in 2013, says data provider Preqin.
It added that for the overall amount of infrastructure, the average deal’s size increased to $549m in 2014 from $329m in 2010.
Still, there is not enough private money being invested in infrastructure, according to OMFIF. On average, pension funds, insurance groups and asset managers invest less than 1 per cent of their total assets in infrastructure, it says.
Simon Walker, director-general of the Institute of Directors, adds: “Infrastructure is one of the most important areas for business. But we need more private investment as the taxpayer can no longer afford to pay for these services.”