PFM, May 2018

Infrastructure investments - a shifting perspective

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 The world wants more infrastructure – a lot more. Whichever forecast you read, the need for infrastructure is staggering.

Given the gap between infrastructure needs and countries’ abilities to fund, the global demand for investment in infrastructure will continue to be very high in the coming years, but realities are changing rapidly in today’s environment.

EY (ey.com/lu) sees the technological disruption, the replacement of old technologies, the changing consumer behavior, the awareness of environmental, social and governance and need for sustainable infrastructure reshaping the way the infrastructure industry operates, shifting its investment perspective and including new variables in any investment or project decisions.

But that’s not all. During the coming years, the increase in urbanization together with economic expansion will push demand for infrastructure to an unprecedented level. Hand-in-hand with these global changes in dynamics and demand, technology disruption will play a huge role in how to approach infrastructure.

Never-ending needs

A recent OECD survey estimates that US$60 trillion is needed for investments in infrastructure worldwide until 2030. From this, modernization and expansion of water, electricity and transportation systems only are expected to cost US$16 trillion in the cities of Western Europe, the US and Canada.

While fast-growing populations are facing a tremendous need for new infrastructure, especially in emerging countries in Africa and Asia where a new middle class is rising, other locations are in need of projects to replace or upgrade aging infrastructure networks.

During the crisis faced in the past few years, national and supranational bud-gets allocated to infrastructure projects have slightly been melted, whereas the current level of investments in infrastructure assets could prevent certain countries from having the expected growth or growing at a faster pace.

Historically, the infrastructure asset class was mostly financed through public funding, governments’ agendas nowadays are changing by turning themselves towards private investors due to public debt limit constraints, unemployment rates and growing populations. This allows public authorities to finance the gap, to develop additional infrastructure assets or to upgrade and replace aging and existing ones at a faster pace than it used to be in the past.

From Juncker Plans in Europe to the One Belt One Road initiative launched by China, there is a strong push from public authorities to create incentives to attract more private capital in the financing of infrastructure.

New game rules

Artificial intelligence, increasing pace of technology replacement, demographic explosion, demand for low-carbon energy and a migration of people to mega-cities are today’s variables that need to be taken into account and are now considered real game-changers when assessing infrastructure investors’ appetite. Consequently, customers’ behavior is also changing, and, therefore, has significant impact on public infrastructure.

Moreover, technology is now clearly upon us and is disrupting the way the asset class is funded, developed and operated, but also perceived in the long run. The historical feature of this asset class is therefore highly impacted by technology considering it imposes a constant assessment and monitoring of variables over quite some years in the future whereas other asset classes (eg, private equity or buyouts) will generally be focused on a relatively shorter-term value creation.

Building an infrastructure is a huge and very strategic investment with long-term implications for a nation which requires assessing the real need for such infrastructure and the risk that such infrastructure could rapidly become obsolete, is becoming absolutely key before taking a decision especially in a bud-get-constrained environment where populations are more and more sensitive to the waste of public money. The consequence of a bad decision or a bad governance can be that the country may just miss the train of the next decade.

This rise of technology in and around the asset class might imply the reconsideration of a business plan, how viable a project could be or the frequency at which variables need to be monitored. As a result, infrastructure, traditionally a conservative asset class, is facing new risks.

On the other hand, security is becoming a run-of-the-mill concern for any player in this market. Each of those ac-tors, eg, governments, investors and investment managers might have interests in defining reduction of infrastructure vulnerability against physical damage, terrorist attacks or cyber-attacks as a top priority for the years to come.

Drift of management spectrum

In today’s environment where investors and asset managers continue to search for yields and returns, there is a shift in risk appetite and business model (ie, a more private equity style of investing).

While infrastructure management style was rather known as long term and steady returns seeking, a clear drift is currently being operated with more private equity players getting on infrastructure playgrounds. Those asset managers are coming alongside their own experience, network and management style. This could lead into higher risks targeting for higher returns and then implying different investment styles. There are also some attempts of the professionals to find innovative structuring solutions through listing vehicles or securitization to make this type of investment more liquid and to attract a wider range of investors.

Clearly the infrastructure asset class is trying to adapt itself and diversify its investment strategies to cover the full spectrum of investors from traditional long-term investors such as pension funds and insurance companies seeking for long-term stable cashflows to traditional private equity investors looking for higher return and mid-term capital gains.

For investors, it will be key to have a clear understanding of asset managers’ objectives so that risk resilience of both will be aligned.

Moving to sustainable infrastructure

ESG is now stated as a new dimension and might be seen as a key criterion when selecting infrastructure projects. Key performance indicators are shifting in achieving sustainability in the long run and having a positive footprint on environmental (nuclear energy, carbon emissions) and social concerns (human rights, aging population).

Investors are increasingly considering ESG factors as a fundamental part when assessing the attractiveness of a project. ESG infrastructure investments are increasingly tending to align investors’ desire for financial return with environmental and social indicators.

When building an infrastructure for several decades, infrastructure players now cannot afford not to take into consideration potential long-term climate change impacts and have to integrate and anticipate these risks in their risk management process. Additionally, building an infrastructure is politically highly sensitive due to its long lasting social and environmental impacts.

Although public private partnerships have been very commonly used in the last 20 years, they are sometimes perceived by the population as a privatization of public facilities and not always popular. Therefore, it becomes predominantly important that infrastructure players take into consideration all these social aspects in their decision and project management. It becomes key to develop innovative financing schemes and business models enabling to better align interests of investors, governments and populations.

For too long, infrastructure has been understood and evaluated solely by the presence of a building or a completed real asset. We know, however, that a hospital cannot function without a sol-id waste system, and a waste system, in turn, cannot function without the acquired and applied knowledge, process-es and underlying resources necessary to manage it. Yet when we talk about infrastructure, this understanding beyond immediate is still too often overlooked. We need to shift this thinking.

Through the above changing investing realities of infrastructure, players within this market will rapidly prove to have agility, flexibility and competencies over the years to make sure to adapt and to consider appropriately how viable projects could be. Both technology and consumer behavior have started to shift and infrastructure players will have to consider to latest consumer needs, eg, how will millennials in developed countries deal with transport?

As investments in infrastructure are deemed to stimulate and support sustainable and countries’ long-term growth, which in turn generates further need for infrastructure, the global demand for infrastructure is likely to increase in the mid-term. However, these realities require more investment discipline and extensive due diligence as the prices of many infrastructure opportunities appear extended.

Smart and sustainable infrastructure to build a better working world...