infrastructure Flashcards
Diversification benefits of Infrastructure Investing
Diadvantage
Illiquid.
Capital intensive and depreciating assets.
High fees, high costs of bidding for and closing deals.
Diversification benefits of Infrastructure Investing
Advantages
Stable return streams with low equity beta.
Potential for high cash flow and growth component
The inflation relation of Infrastructure Investing
disadvantage
Some assets may only partially adjust for inflation.
While cash flows may be linked to inflation there may be a material lag.
The inflation relation of Infrastructure Investing
advantage
Revenues may be either explicitly linked to inflation and/or may offer inelastic demand patterns.
Characteristics of Infrastructure Investing
Advantages
Most infrastructure assets have long, stable cash flows.
Concessions for infrastructure tend to be long-term and over 25 years, often lasting 99 years.
Provision of essential services result in monopolistic market structures
Disadvantage
Regulatory uncertainty.
Political risk.
Patronage and construction risk for value add or greenfield investments.
Provision of essential services result in monopolistic market structures
Predictable cash flows.
Higher credit ratings resulting in favourable borrowing costs (typical gearing levels for core infrastructure 30 – 45%)5.
Limited business risk
mature and developed markets infrastructure (core) investment returns feature
this stable, reliable and protected income stream, which is derived from tangible, long-lived assets with monopolistic like pricing power.
new-construction investments, risk and return
opportunistic strategies would include ‘greenfield’ or new-construction investments, and would generally be structured with higher risk exposures to the cash flow stream.
RISK PREMIA
A skill premium
can be expected across the core and value added spectrum given the unique capabilities required; from originating deals through to navigating complex regulatory environments.
RISK PREMIA
of value-added infrastructure
would be expected to earn additional premiums related to the risk of establishing patronage and a construction premium.
RISK PREMIA
of core infrastructure
core infrastructure provides stable and predictable revenues, and this suggests a moderate return premium over a reference long-term bond rate to reflect limited business risk and an illiquidity premium
we would expect that the core infrastructure specific equity risk premium to be lower than the broad equity market over the long-term given the lower risk.
Given the nature of unlisted infrastructure returns, investors often question whether the categorisation of the asset class should be defensive or growth.
The certainty around cash flow streams of many infrastructure assets supports a defensive categorisation
we consider unlisted infrastructure to be a growth asset. In our view, although the asset class may be more defensive than say, equities, it still requires a growing economy to deliver on its capital growth and income return objectives.
advantages of infrastructure investments
inflation linked stable income stream and the monopolistic pricing power asset owners possess
Australian unlisted infrastructure
The airport sector performed relatively well through
GFC including the diversity of revenue streams
Although performance of the airports may slow with a further downturn in the Australian economy resulting in a slowdown in passenger growth, they have sound and sustainable capital structures
Australian unlisted infrastructure
exposure to airport
significant allocation to airports held by a large proportion of the dominant unlisted infrastructure managers in Australia
currently, airport sector is lightly regulated.
The sector in Australia has a strong track record of long-term growth with far less PAX growth compared to Australian equities
The underlying discount rate to value unlisted infrastructure investments is lower
the trend to lower bond rates in key countries such as the US, UK and even Australia would be expected to reduce the discount rate for assets located in those countries and, assuming no change in the risk profile, this would in turn bolster valuations.
However anecdotal evidence suggests that valuers appear to be taking a conservative approach and either:
Explicitly adjusting the risk free rate so that it does not reflect the extremely low current bond yields; or
Adding an alpha factor to offset the reduction in long term bond yields.
The valuation of unlisted infrastructure investments will generally require
assessment of their specific cash flows and investment terms by an independent valuer, with the valuation often based on a DCF approach.
DCF value is the summation of all future cash flows generated by an asset, where cash flows are adjusted for the time value of money and risk, as well as (usually) tax. For a given set of cash flows, the lower the discount rate the higher the valuation.
GREENFIELD RISKS
These high profile failures have made it harder to
attract private investment into new greenfield infrastructure projects. I
GREENFIELD RISKS
There have been some criticisms in the past that the system of tendering for infrastructure projects institutionalises a winner’s curse by
encouraging overly-optimistic predictions by advisers and consultants who are incentivised to overstate projections to earn success fees, irrespective of whether or not the forecasted patronage materialises after construction
GREENFIELD RISKS
Although infrastructure is typically characterised as having relatively inelastic demand and a low risk profile, infrastructure assets are not immune to failure. The mid to late part of the 2000’s has been notable for some high profile infrastructure projects being funded on the basis of overly optimistic forecasts of usage.
Although infrastructure is typically characterised as having relatively inelastic demand and a low risk profile, infrastructure assets are not immune to failure. The mid to late part of the 2000’s has been notable for some high profile infrastructure projects being funded on the basis of overly optimistic forecasts of usage.
two issues with performance fee structures for infrastructure investments.
Does this sit for mature infrastructure?
assets that are mature, comparatively lower risk and subject to a greater degree of regulation, have material scope to add value for a performance fee to be appropriate.
two issues with performance fee structures for infrastructure investments.
. Firstly, the appropriate benchmark and
secondly, performance fee structures are generally associated with asset classes where there is significant scope to add value. e.g. greenfield infrastructure,
Many unlisted infrastructure funds have adopted a fee structure which
comprises of a base plus performance element
the late 1990’s, 2% base and 20% performance fee structures were common. While performance fees of up to 20% are still common, base fees have generally materially reduced.
assuming the benchmark issue is suitably addressed, we consider that the appropriateness of performance fee structures is dependent
on the underlying nature of the infrastructure investments with the existence and scale of any performance fee reflecting the attached value enhancing opportunity.
e.g. For example, a base fee only structure for mature core infrastructure with the scale of a performance fee rising in proportion with the proportion of greenfield opportunity.
IMPACT OF A CARBON PRICE ON THE INFRASTRUCTURE SECTOR
Increased use of public transport
Likely impact on infrastructure
Growing demand for public transport infrastructure as well as increased strain on current infrastructure.
IMPACT OF A CARBON PRICE ON THE INFRASTRUCTURE SECTOR
Reduced discretionary spending
Likely impact on infrastructure
Decrease in tourism traffic will impact tourism-related infrastructure such as airports.
IMPACT OF A CARBON PRICE ON THE INFRASTRUCTURE SECTOR
Higher energy prices, construction costs and a short term increase in price inflation
Likely impact on infrastructure
Higher inflation will flow through to CPI-linked infrastructure investments.
Higher construction costs will drive up the cost of new infrastructure projects.
IMPACT OF A CARBON PRICE ON THE INFRASTRUCTURE SECTOR
Higher energy prices, construction costs and a short term increase in price inflation
Increased use of public transport
Reduced discretionary spending
One of the key upcoming economic developments that will alter the Australian infrastructure landscape is the almost inevitable transition to a low carbon economy.
how
Those sectors within the industry that are carbon emissions intensive may find themselves in a position where they have to implement drastic changes to the way they operate
transitioning to a low carbon economy will see large changes in the Australian economy. This will be most pronounced in the
electricity generation sector and Russell Investments believes this will be a key area of opportunity for infrastructure investment in the medium term.
asset classes with no good database
unlisted infrastructure
Unlisted infrastructure investment comes with
only for
substantial risk
institutional investors
Risk of infrastructure comes from
uncertainty in cash flow, the quasi-gurantee - protection from gov
listed infrastructure
and exposure to equity
easier to access as a small investor but less diversified than listed property and higher correlation with equity than unlisted infrastructure
Infrastructure – the truth of it
cash flow risk can exist when
–Construction and development risk (successful of project)
–Not all infrastructure is regulated and monopolistic
–Exposure to economy and substitution
–No supportive evidence to show close correlation with inflation
Infrastructure looks very attractive asset:
diversifier of equity risk (low correlation; labelled as defensive)
- Stable cash flows (essential services, monopolistic)
- High barriers to entry (regulation, capital costs)
- Revenues often linked to inflation
higher return than cash or fixed income.
Infrastructure – the truth of it
•Occasional use of extreme leverage
Esp if gov is involved. Leverage can be up to 90%. For construction, both public and private will contribute. Private companies will operate and get profit and after 20-30, will return ownership of infrast to gov. Sometimes leverage can bea problem. For investors who have clear defintion from mandate of leverage exposure ad risk exposure of high leverage
unlisted infrastructure
limited info of the risk and E® because valuaton is subject to the modelling of the managers
Listed infrastructure
more regulation and discloure. Understand the projects they are investing in. better understanding of the risk invovled
