The significant rise of infrastructure as an asset class has been underpinned by three key demand factors. Firstly, the collapse of bond prices in many developed economies has led investors to search for yield by other means. Secondly, large inflows of capital have motivated institutional investors to pursue alternative investment options (i.e. asset classes other than equities and fixed income), which has contributed to the overall demand for infrastructure assets. Finally, investor awareness and knowledge of infrastructure has increased.
Investor 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, the infrastructure asset class has become one of the prime beneficiaries of this search for yield.
High volume of capital inflows
With the growing maturity of pension schemes across the world, pension funds are receiving an increasing amount of funds to manage. Take Australia as an example, its superannuation scheme was implemented in 1992 and, having experienced significant growth, funds under management in the Australian superannuation system have now grown to US$1.37 trillion and are forecast to grow to US$3.43 trillion by 2043. Already the funds under management in the superannuation sector far exceed the value of the Australian stock market (approximately US$1.1 trillion as at December 2015). This trend has contributed to institutional investors increasing participation in alternative investment markets.
Increased awareness among investors
The increased understanding of infrastructure investments that investors have developed has also resulted in its increased popularity. Specifically, 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.
Changing dynamics of the infrastructure market
While the rise of infrastructure has provided many opportunities, it also presents significant challenges moving forward. Specifically, the increased appetite for infrastructure has led to increased competition for infrastructure assets and, as a result, increased asset prices.
In 2014, Australian ports Port Botany and Port Kembla were acquired for multiples of 25 times earnings before interest, taxes, depreciation and amortisation (EBITDA), and the Port of Newcastle was sold for 27 times EBITDA. These multiples are materially higher than historical multiples for similar assets. Perhaps the most publicised examples of high multiple infrastructure transactions in 2015 have been the sales of the Indiana Toll Road for US$5.7 billion and the Chicago Sky Way for US$2.84 billion, which were estimated to be approximately 32 times and 35 times EBITDA respectively.
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.
Rising to the challenge
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.
However, identifying and driving value in such investment opportunities is not for the faint hearted and requires global teams of experienced industry professionals, who have extensive industry networks and expertise allowing them to navigate across industries and markets to source new opportunities. This includes assessing the relative sources of value between yield and growth businesses and focusing on those opportunities with the highest relative value potential for investors.
In pursuing such a strategy, there is merit in assuming such exposure through diversified, mid-market-focussed infrastructure funds. This type of approach brings with it the benefits of risk diversification, both by geography and by sector.
Final thoughts
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 increased operational and market risks and investors looking to make such investments should consider accessing these through co-mingled funds and appropriately skilled managers.
Source: AMP Capital
About the Author
Boe Pahari, Global Head of Infrastructure Equity, Managing Partner
With more than 20 years experience in Sydney, Singapore, Amsterdam, New York and London, Boe has led the creation and development of principal, advisory and banking businesses across several prominent financial institutions.
Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.
