A different landscape: Infrastructure investing in the United States
Fifteen years ago the landscape of infrastructure investing was vastly different than it is today. Having been largely government funded in the United States, infrastructure was not on the radar of most investors. That has since changed.
As more countries opt to privately fund infrastructure, investors are flocking to the opportunities. “Investment consulting firms, particularly in the United States, were just beginning to learn about the risk and return characteristics of infrastructure and its potential role in institutional portfolios some 10 years ago, whereas today infrastructure is no longer considered an alternative investment,” says Mark Weisdorf, managing partner of Mark Weisdorf Associates.
The evolution of infrastructure
Unlike much of the developed world, the United States has been slow to move away from reliance on federal, state and local governments to fund and operate large-scale infrastructure projects, rather than the private sector. “Allocations and commitments from pension plans and insurance companies have grown in many countries to an average of between 5 and 10 percent — or more — of total portfolios,” says Weisdorf.
P3s, or public-private partnerships, have been gaining popularity over the years, but it was not until 2005 that a major public infrastructure asset was privatized in the United States. A $1.8 billion, 99-year concession agreement was reached that year by the City of Chicago and a partnership of Cintra Infraestructuras and Macquarie Group to privatize the 7.9-mile Skyway. A year later the same partnership acquired the 157-mile Indiana Toll Road for $3.85 billion.
Australia, Canada and the United Kingdom, on the other hand, have been quicker to privatize large-scale infrastructure assets and outside pension plans are beginning to turn their sights on the United States. Not only are more investors interested in infrastructure as an asset class, but more opportunities are becoming available as well. Gregory Smith, president and CEO of InstarAGF Asset Management Inc., sees promise in localized microgrids.
“Large-scale utilities have become an outdated model that is slowly collapsing under shifting load patterns and the declining cost of energy storage and renewable energy infrastructure,” says Smith. “As a result, localized microgrids, or distributed energy systems, and new district heating projects, particularly in the municipalities, universities, schools and hospitals (MUSH) sector, are presenting some interesting and transformative investment opportunities that would not likely have been available 15 years ago.”
Despite the growth seen during the past 15 years in private infrastructure investing, the United States still lags behind other developed nations. So why is it not more mainstream?
Why investors are reluctant
There are a number of factors keeping investors away from infrastructure, but the risks are relatively low compared to other asset classes.
The main risk involved with infrastructure investing is political. Because the assets are still owned by the government, changes in regulation and policy, or shifting political agendas or cycles, can have a significant impact on the operations and revenue of infrastructure assets.
“There have been some stumbles, such as the handover of management of the Chicago parking system, and the insolvency and restructuring of toll roads in California, Indiana, and Texas, that have made the news and caused concern,” says Weisdorf. “However, transparent regulatory and concessionary regimes have yielded good results, attracting private sector investment for the refurbishment, expansion and building of new, more efficient infrastructure, where governments were hard pressed to finance infrastructure requirements from tax revenue or debt issuance — due to other priorities.”
Weisdorf adds that Australia, Canada and the United Kingdom provide good examples of transparent and fair regulatory decisions and public-private partnerships.
Another issue some investors see with infrastructure investments is the illiquidity. While investments in other asset classes can have faster turnaround, the bulk of an infrastructure commitment will be tied up for five to 10 years.
Then there is the complex nature of infrastructure investing, which is often the number one hurdle to investors when considering the asset class. Some investors with the resources have opted to build internal teams to make and manage investments, but most cannot achieve this.
According to Smith, successful infrastructure investing requires deep expertise in a specific sector. “Infrastructure assets with the same physical characteristics can represent very different investment opportunities, with the risk/return balance contingent upon the maturity of the asset, geographical and sector diversification, and asset-specific supply and demand drivers,” Smith says. “Given these complexities, managing an infrastructure program in house simply isn’t possible for many institutional investors.”
The up side
Unlike real estate and other asset classes, many infrastructure assets are more resilient to the economic cycle. The necessity of infrastructure to everyday life makes the assets less volatile. The essential nature of infrastructure assets — people need water and power delivered in good as well as bad economic times, for example — ensures their continued use even in weaker economic periods.
In addition to their relatively lower risk, infrastructure assets produce higher yields than many other asset classes. “Infrastructure — outright monopolies or — with monopolistic characteristics, is arguably lower risk, and yet generates higher returns than real estate, which is generally more cyclical and dependent on factors such as location, tenants and economic and interest rate cycles, which impact vacancies, rents, and ultimately, free cash flow and distributable cash flow,” says Weisdorf.
What new investors should know
As more and more investors move into infrastructure, they can learn from those who have been active in the asset class for a while now.
Smith, who has been active in the infrastructure market for almost two decades, notes that it is important for investors to keep in mind the complexity of the asset class. “It takes deep operational know-how to improve how an asset actually runs, which in our experience is the secret to generating significant alpha. For those reasons, investing in unlisted funds with seasoned investment professionals, or as a co-investor alongside a fund, typically provides access to the diversity, quality and returns investors are seeking but at a lower risk than doing it themselves,” he says.
Smith adds there are three main considerations that shape an infrastructure investment strategy: whether to target large-scale or medium-scale investments, whether to pursue a global strategy or to specialize regionally, and whether to focus on core or core/value-added infrastructure.
Weisdorf is a bit more specific with how to get started, “1.) Start with a portfolio of core/core-plus assets diversified across subsectors and OECD member country geographies; 2.) Don’t consider your developing infrastructure portfolio in isolation, but rather as part of a larger portfolio of real estate, or real assets; 3.) Don’t delay before beginning to selectively add medium risk/return strategies, like ‘build-to-core’, platform investments, publicly traded infrastructure, mezzanine debt, infrastructure in higher growth economies, as well as strategic joint ventures or separate accounts strategies, to enhance risk-adjusted returns beyond core/core-plus or beta/beta-plus base portfolios.”
The future is (almost) here
“Infrastructure investing will become as mainstream as real estate investing,” says Weisdorf. “As it already is in Australia, Canada, the U.K. and elsewhere.”
As mature markets outside the United States have reached saturation, investors are looking at the country for growth potential.
Weisdorf adds, “It’s been slower to develop in the U.S. than many had hoped, but as the American Society of Civil Engineers reminds us every few years, deferred maintenance continues to grow, while the safety and reliability of our nation’s infrastructure continues to decline.”
The need for private investment is continuously growing every day as governments struggle to maintain current infrastructure as well as develop new projects. “We need to make better and smarter use of existing infrastructure,” says Smith.
Investors looking to build an infrastructure portfolio right now have the benefit of utilizing the experience of those already in the market and getting into the market right as it’s beginning to grow exponentially.
“It may take another 10 years, but infrastructure deal flow in the United States will attract allocations and commitments rivalling those of real estate,” says Weisdorf.
Zoë Wolff is a freelance writer based in Boise, Idaho.