Investment in infrastructure – an apt solution for the 2021 investorSunday, January 17, 2021
BY SIMONE HUDSON
EXPOSURE to infrastructure assets can provide investors with the higher returns, stability of income, and portfolio diversification they have been searching for since the pandemic.
COVID-19 and the impact it has had on prices across asset classes has underscored the importance of building resilient portfolios that can effectively lessen the effects of short-term shocks.
To achieve this, investors are now more focused on finding investment securities that offer greater stability in times of market uncertainty, which has opened the door to alternative investments – one of those being infrastructure assets.
An infrastructure fund is a financial asset that provides the opportunity to invest in essential public assets that people rely on to function in their everyday lives, work, and travel.
These include economic assets such as transport (toll roads, airports, and railways), energy, utilities, and communication facilities, as well as social assets including hospitals, schools, stadia, parks, and others. These assets are critical in creating higher-quality opportunities for employment, health care, and education, and increasing the pace of economic growth.
Infrastructure assets typically operate in industries characterised by low levels of competition, high barriers to entry, and have relatively stable prices because of their essential nature and often stable cash flow.
As a result of these factors, demand for infrastructure assets is similar to that of other non-discretionary consumer goods, making them resilient to economic changes. Infrastructure funds are often managed by specialist fund managers, who make investment decisions on behalf of investors to generate capital gains and/or meet predetermined income objectives.
There is a significant demand for funding for infrastructure assets in Latin America and the Caribbean (LATAM) due to underinvestment and the fiscal challenges now faced by governments in the region.
This creates a market opportunity for the development of a regional infrastructure fund to help bridge the gap.
Currently, investment in the sector accounts for around 2.8 per cent of gross domestic product (GDP), while many international studies indicate that to bridge the gap, LATAM countries should allocate between 4 per cent and 7 per cent of total GDP to this sector over a sustained period.
If the region does not step up its infrastructure investment spending, the Inter-American Development Bank estimates that these countries could lose an average of 15 per cent of their GDP over the next 10 years. However, as the impact of the pandemic on government coffers has reduced their scope for public investment in infrastructure, the role of private sector infrastructure investment becomes greater.
In Jamaica, for example, in light of the additional expenditure required to fight the effects of COVID-19, the Government reduced its capital expenditure budget from $74 billion to $46 billion.
Therefore, in this scenario with governments across the Caribbean reducing their investments in infrastructure due to fiscal constraints, a natural solution to the problem is to seek out private investors to cover a portion of the investment needed. This paves the way for the generation of a steady pool of investment opportunities for private infrastructure funds.
For long-term investors seeking income and capital growth, infrastructure funds possess unique characteristics that offer numerous benefits. The first of these is the generation of relatively predictable and sustainable cash flows. Because most infrastructure assets provide essential services to the markets they serve and are often the only provider of the service, demand is often very stable. Further, infrastructure assets are often physical or hard assets and, once built, exist for generations, so the contracts underpinning the provision of infrastructure services tend to be long term with predictable revenue streams to match their long life. Moreover, the rates charged by service providers (think toll roads) are primarily determined by regulators, and long-term Government contracts, which allow adjustments to be made for inflation over the contract life.
Given that the services provided by infrastructure assets are essential for the functioning of a society, governments must also allow private owners to earn fair returns to incentivise them to keep the facilities in good working condition and invest for future growth and modernisation.
Therefore, infrastructure funds tend to offer attractive yields, and those in developing markets have also been shown to offer investors more favourable returns relative to that available on developed global markets.
Investors can also realise diversification benefits and access to an otherwise inaccessible asset class. As a result of the unique characteristics outlined above, the return on infrastructure assets do not bear a strong positive relationship with other major asset classes, resulting in compelling diversification benefits. Infrastructure funds with investments in assets across multiple Caribbean states will also provide regional diversification benefits, limiting concentration risk/exposure to a single country and increasing the return potential. However, given the very high capital investment required to build infrastructure, individuals are unlikely to be able to invest directly in them. Therefore, investing in a fund gives small investors access to an otherwise inaccessible asset class with exposure to a broad range of assets.
Infrastructure funds can simultaneously create new investment opportunities for investors while they assist countries to fund their economic recovery, generate higher long-term growth, and improve standards of living. Importantly, with governments increasingly hard-pressed to obtain the capital required to maintain, modernise, and expand their infrastructure, they have begun to recognise that private sector capital can be used to satisfy those infrastructure needs.
These trends present a significant opportunity for investors to acquire, manage, and reap the benefits of owning high-quality assets across the region. Through these assets, investors can gain higher yields, stable income, and more resilient investment portfolios.
Simone Hudson is the assistant vice-president, alternative and fund management at NCB Capital Markets.
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