First, it’s important to ensure that a particular investment opportunity matches the definition for an infrastructure asset. Certain assets—such as fibre optic cable networks and satellites—are often described as infrastructure but have volatile return characteristics and operate in competitive environments, which can be deceptive from a risk/return perspective. Furthermore, every infrastructure investment has its own unique risks that may have an adverse impact on returns. These risks include the following:
- commodity – uncertainty of future commodity prices due to fluctuations in market prices (natural gas);
- pricing – uncertainty in future electricity prices due to market fluctuations (electricity generation);
- demand – uncertainty of future usage (toll roads);
- construction – uncertainty with timing of operational launch and future use (toll roads under construction);
- regulatory – uncertainty regarding future pricing reviews or the risk that changes in laws or regulations will negatively affect the business;
- technology – uncertainty of future technological developments (communications, infrastructure); and
- financing – risk of default or of not being able to refinance debt at attractive rates.
Once the investment risks are properly researched and understood, investors can more appropriately price the assets.
How big is the opportunity?
Overall, the global market for infrastructure investment is enormous, with estimates as high as $20.5 trillion (including both publicly and privately held assets). The majority of infrastructure in Canada is nearing the end of its useful life and has suffered from massive underinvestment over the past 30 years.
Despite their best efforts, governments at all levels lack the financial resources to pay for these upgrades. A 2007 report from the Federation of Canadian Municipalities estimates Canada’s infrastructure deficit at $123 billion, which greatly exceeds the $33 billion earmarked in the 2007 federal budget for the government’s Building Canada infrastructure plan. This presents a tremendous opportunity for private sector investment to help fill the gap.
In recent years, the public/private partnership (P3)—which originated in Australia in the early ’90s—has become a popular funding model for infrastructure projects for increasingly cash-strapped governments. P3s are contracts between government and private sector entities for the provision of assets and the delivery of services that allocate responsibilities and business risks among the various partners.
Typically, the private sector is responsible for the more commercial functions, including design, construction, financing and operations. The Canadian P3 market is maturing, as a number of early P3 projects have now been successfully completed and are in operation, such as Highway 407 in Ontario. Now that the model has been proven, interest in using it has spread across the country.
How can I access this sector?
The appropriate strategy will depend on your organization’s size, available internal resources and level of experience with the sector.
The easiest way for an organization to start an infrastructure investing program is to invest with external investment managers through vehicles such as open-ended mutual funds or closed-ended infrastructure funds (public or private). This strategy will allow your organization to learn about the industry from world-class investors and limit the concentration risk (when too much capital is allocated to too few investments).
Fund investing is also an attractive option for organizations that cannot dedicate the internal resources necessary to source, evaluate, structure and actively manage direct investments.
Once your organization has sufficient resources dedicated to its infrastructure investment program, a direct approach can provide more discretion over the allocation of capital and will help to lower the costs and fees associated with external investment managers.
For smaller plans, direct investing opportunities come in two forms: co-investments and syndication investments. (A syndicated co-investment occurs when the lead investor sells part of an investment to smaller investors after the transaction is complete.)
Direct investing will allow your organization to make more concentrated investments in individual assets and will provide the option to hold investments beyond the typical fund life, reducing the expenses associated with recycling investment capital.
At the same time, a direct investment strategy is much more time-consuming and will require more internal resources to execute transactions and effectively monitor the investments.
Infrastructure investing is accessible to pension plans of all sizes. There are products in the market to fit any investment strategy or objective—whether the focus is equity or debt investing, country- or geography-specific, asset type-specific, or yield- or total return-driven. Despite the concerns and risks, infrastructure remains a compelling asset class as a means of achieving strong risk-adjusted returns.
George So is a partner and Alex Jerome is an associate with Kindle Capital Management Inc. gso@kindlecapital.com; ajerome@kindlecapital.com
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