For Professional/
Institutional Investors only
An introduction to infrastructure
as an asset class
Infrastructure has been attracting
greater attention in the global
investment community. Private
sector capital is expected to play an
increasing role in light of the budgetary
constraints faced by many governments
around the world.
Defining infrastructure assets
Infrastructure assets are the facilities
and structures essential for the
orderly operations of an economy.
Transportation networks, health and
education facilities, communications
networks, water and energy distribution
systems provide essential services to
communities. Examples of infrastructure
assets include:
• Transportation assets such as toll
roads, airports, ports, bridges,
tunnels and rail
• Utility and energy assets such as
water, power generation, electricity
and gas networks, and fuel storage
facilities
• Communications infrastructure such
as transmission towers
• Social infrastructure such as
education, recreation, waste
management and healthcare facilities
The high barriers to entry and the
monopoly-like characteristics of typical
infrastructure assets mean that their
financial performance should not be
as sensitive to the economic cycle as
many other asset classes. Investments
are generally low risk given the stable
and growing demand for the essential
services provided, together with the
regulation of the businesses and/or longterm contractual protection of revenues.
Globally, only a small fraction of
infrastructure assets are currently listed
or under private ownership. Notable
examples include the water sector in
the UK, the power generation sector in
North America and many roads, ports
and airports in Australia. Thus resulting
in a huge potential for increased
securitization. Drivers of future growth
include demographic trends, the
increasing role of private capital and
increasing turnover of existing privately
held assets.
In general, investors who focus
on yield and managing long-term
liabilities, such as pension funds, will
find infrastructure assets attractive. In
addition to benefiting from enhanced
diversification, these investors can
use infrastructure to help match their
liability profile with a predictable and
partly inflation-linked distribution
stream. Given its relatively low
correlation with traditional asset classes,
infrastructure can also play a valuable
role in the risk-return optimization of a
portfolio and should be considered in
strategic asset allocation decisions.
So what exactly is infrastructure; how
does it compare with other types of
investment; what are the risks; and how
can investors gain exposure to this new
asset class?
Infrastructure as an asset class
Infrastructure could always be
considered an asset class by definition,
however, it has only in the past few
years been more widely accepted as a
‘pure play.’ In some parts of the world
– for example, Australia, Canada and,
to some extent, the UK – infrastructure
for many years has been considered
to be an asset class in its own right.
The relatively long operational lives
and high operating margins of
infrastructure projects are appealing to
private capital investors. The popularity
of infrastructure assets is increasing
among investors as it offers reliable
long-term cash flows usually with some
form of inflation protection.
A relatively recent innovation is the
packaging of a portfolio of these assets
into pooled vehicles – infrastructure
funds – that offer longer-term, highyielding, defensive, risk-adjusted
returns. A portfolio of defensive
infrastructure assets is characterized
by its low correlation to other asset
classes and its relatively high inflationlinked cash yield. It is this combination
of characteristics that supports the
argument that infrastructure warrants
its own allocation within an investment
portfolio. These funds are well-suited
to pension funds and other long-term
oriented investors seeking steady,
reliable returns.
Infrastructure fund managers are
typically value investors with a focus
on the cash generative potential of
targeted assets. The infrastructure
fund manager is responsible for the
sourcing of deal flow, the execution
of transactions (both acquisitions, and
later in the life of the fund, divestments)
on behalf of the fund, and the ongoing
management of those assets held by
the fund.
Infrastructure managers employ
execution and asset management teams
that are comparable to private equity
investment teams, albeit with specific
skills and experience in relation to the
regulatory and market considerations
that apply to infrastructure assets.
How does infrastructure compare
with other asset classes?
Infrastructure investment shares some
of the characteristics of fixed income
(long-term predictable cash yield), real
estate (investing in physical assets)
and private equity (geared investment
albeit with substantial differences in the
underlying risk attributes).
How does infrastructure fit into a portfolio?
Infrastructure has a risk/return profile between equities and fixed income
Similarities
Differences
Private equity
•Management control over investments
•Converging investment techniques
•Different risk-return objective; lower exposure to economic cycle
•Longer investment horizon; return less driven by exit strategy
•Strong cash yield/lower capital growth
Real estate
•Cash yield is significant part of return
•Absolute return objective focus
•Importance of location
•Control over operating companies
•Barriers to entry; less exposure to valuation cycles
•Longer cash flow predictability, higher gearing
•Normally larger individual asset size
Equities
•Equity ownership
•Upside return potential
•Lower level of securitization/liquidity
•Lower correlation with business cycle
•Relatively predictable and high cash yield
Fixed income
•Long-term, predictable cash yield
•Long duration asset
•Low market risk
•Asset ownership
•Growth/upside potential
•Inflation hedge features
•Indirect exposure to interest risk
Source: UBS Global Asset Management
However, the fact that infrastructure
assets have substantial barriers to entry
and often supply essential services
means that they tend to be less
exposed to economic cycles and can
accommodate higher levels of gearing.
This is because defensive infrastructure
assets generate stable cashflows that
can support higher levels of debt
service in good and bad times, i.e.
across economic cycles. More detail on
the similarities and differences can be
found in the table above.
Risks
Although infrastructure assets are
generally viewed as being relatively low
risk, they are exposed to a number of
infrastructure specific risks:
Patronage/demand risk
Some assets, such as transport assets
like toll roads, ports or airports are
exposed to usage or patronage risks
which vary between assets and over
time. Generally, transport assets are
therefore pro-cyclical.
Regulatory risk
Infrastructure assets are very often
regulated by government either through
a regime set by a regulator or through
long-term concession agreements. The
independence and consistency over
time of the regulatory system is a key
risk factor for investors.
Contractual/credit risk
Long-term contracts expose
counterparties to credit and other risks.
Operational/construction risk
Infrastructure assets involve operational
risks and greenfield projects involve
construction risks.
Financing/inflation risk
The leverage involved in financing
infrastructure assets exposes investors
to the cost of debt and refinancing risk.
The value of cash flows may also be
impacted by inflation.
The risks outlined above will have
varying degrees of influence on
whether an infrastructure investment
is appropriate. A toll road and hospital,
for example, have unique characteristics
that will influence their distinctive risk
profile. In addition, the investments
will be subject to typical investment
risks such as the price paid, ongoing
management and ultimately liquidity.
As a result, as is the case with most
investments, it is important to ensure
the risks are fully understood at the
outset and the portfolio appropriately
diversified and balanced.
Investing in infrastructure
With a recent increase in funds in the
infrastructure sector, a growing number
of pension funds and other institutional
investors across the world are looking
to include infrastructure in their
investment portfolios.
Investment in infrastructure can
generally be made in five broad forms:
• Direct infrastructure investment
• Unlisted funds investing in direct
infrastructure and/or listed
infrastructure companies
• Listed funds investing in direct
infrastructure and/or listed
infrastructure companies
• Listed stocks
• Fund of infrastructure funds
In the case of investment funds, the
investor must first decide on a fund
manager. So what should you look for
in an infrastructure fund manager?
Investment team experience
The quality of the investment team is of
overriding importance to the success of
infrastructure funds. The team needs to
demonstrate in-depth sector knowhow, strong transactional capabilities
(for example, principal investments,
advisory work, capital markets) and
deep asset-level operational experience.
Deal sourcing and investment process
With an increasing number of managers
chasing infrastructure assets, access
to quality deal flow and a disciplined
investment process are of paramount
importance. A fund manager’s
reputation and deal sourcing network,
its experience and skills to select the
best opportunities in line with the
fund’s investment mandate as well
as strong deal execution capabilities
represent critical manager attributes.
Asset management capabilities
The ongoing management of
infrastructure assets may be either
passive (in the case of smaller stakes
in listed investments) or active (in the
case of significant stakes in either
listed or private investments, including
direct investments). In the case of
active management, a quality manager
will seek to add value by pursuing a
hands-on asset management approach
with a particular focus on areas such
as strategic planning, enhancement
of operational performance and
optimization of capital management.
Fund governance
The alignment of interest between the
fund manager and investors is critical.
Investors are therefore increasingly
focusing on strict governance
procedures, no conflicts of interest and
transparent fee structures.
Infrastructure sector – key themes
The changing economic and policy
environments mean that the
infrastructure investment sector faces
a range of issues and opportunities. A
number of globally relevant themes are
summarized below:
Climate change
Climate change legislation and regulation
of greenhouse gas emissions clearly
represents a key area of interest for
infrastructure investors. Subsidies and
other support to the renewable energy
sector provide a good example of the
potential impact of policy and associated
regulations on investment activity.
Over the past decade, the experience
of investors in Germany, Spain and
some of the North American regions
demonstrated the extent to which
subsidies can accelerate the development
of the sector but also cause a slowdown
in development activity once economic
support is reduced.
Source: UBS Global Asset Management
Government finances
The deterioration of government
finances, in particular in many
developed countries, represents another
important issue for infrastructure
investors. Fiscal stress suggests that
private capital will be increasingly
needed for financing infrastructure
capital expenditures which represents
a key opportunity for investors. The
concerns around the sustainability of
public finances will require governments
to reduce spending and find alternative
financing solutions for investments.
Furthermore, the way governments deal
with their financial balances will be an
important driver of economic growth.
Indirectly this will impact infrastructure
projects exposed to demand volatility.
could mean an increasing demand for
assets that are structured to provide an
inflation hedge and a growing focus
on differentiating between assets that
have explicit inflation links and those
that do not.
Debt markets
The availability and terms of debt
will remain a major driver for overall
infrastructure investment activity. While
debt markets have strongly recovered
since the financial crisis, a number of
structural changes arose over the past
two years some of which are likely to
persist over the medium-term. These
include the shift from bank to bond
markets as most banks will have to
continue to strengthen their capital and
liquidity position as well as the reduced
appetite for long-term project debt. The
state of debt markets will be important
for the financing of new investments
and also be critical for the significant
refinancing needs of the sector over
the next few years. The strength of
the corporate bond market including
the re-emergence of the high yield/
subinvestment grade market in the
past year is generally seen as a source
of funding which will ease some of the
pressure around refinancings.
Partly due to the expansionary
monetary policy response to the global
financial crisis and also reflecting a
post crisis shift in credit standards
(i.e. tolerance for leverage), expected
returns have declined across a number
of markets and asset classes. However,
on a risk-return basis, infrastructure
remains a compelling asset class.
Inflation
Considering that investors often seek
inflation hedging through infrastructure
investment, the outlook for inflation is
an important consideration. Uncertainty
around future inflation was limited
for the decade preceding the global
financial crisis. However, the current
outlook is a lot more uncertain. For the
infrastructure sector this uncertainty
Investment returns
There has been a significant increase
in recent years in the number of
infrastructure funds and the size of
assets under management. However,
this does not necessarily reflect a
disproportionate supply of capital
chasing infrastructure assets. The
market expansion reflects the rapid
development of the asset class from a
low base, rather than an oversupply of
capital.
Contacts
Kate Martin
Investor Relations Executive
New York
Tel. +1 212 821 6557
Mobile +1 347 439 8336
[email protected]
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