The recent trend of increased private sector ownership of infrastructure assets has resulted in a surge of investment into the asset class, but investors need to realize that the term ‘infrastructure’ does not guarantee profitability, according to an expert.
In a speech to the Toronto CFA Society on Tuesday, Rob Prugue, senior managing director at Lazard Asset Management, explained that examples of unprofitable infrastructure assets abound, and investors should closely study all external factors before committing to a project.
He described the construction of the Chunnel between England and France as an example of what can go wrong when the asset is faced with stiff competition and cannot control the price of the service. “After completion of the project, airline deregulation and improved ferry service meant that the traveler was no longer beholden to the Chunnel,” Prugue said. “They were unable to control the price, and a deficit quickly followed.”
According to him, investors should seek out preferred infrastructure, consisting of assets which meet the criteria of revenue certainty, profitability, and longevity. “The main question to ask is, is it a monopoly?” Prugue asked. The Chunnel case was marked by an inability to compete, he explained, which should teach investors to seek out assets that have little or no competition and are therefore able to set the price to ensure profitability.
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He added that listed infrastructure (which trades on stock exchanges) is preferable to non-listed infrastructure as it is diversified, highly liquid, and is the largest infrastructure universe. Such assets tend to exist in first world countries such as Japan, Canada, and France.
Investing in infrastructure has significant risks, explained Prugue, and potential investors should be mindful of regulatory, political (hence the preference to OECD members), and real interest rate risk. He said that infrastructure companies may be more highly geared and owned in more elaborate funding structures than is typical of companies in other sectors, introducing additional risk.
Prugue also warned that their funding structures, as well as the manner by which the capital market values such long duration assets makes their pricing subject to risk from movements in real interest rates. “Infrastructure is less risky than other alternative investments, but it is still risky.”
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