The money involved in infrastructure is staggering, so why is so much of it unspent and uninvested, asks EIX’s Steve McDowell.
Nothing is small in infrastructure investment and that includes the sums of money involved – they just don’t get any bigger.
Everyone involved in the infrastructure industry, from the nuts and bolts man to the retail fund manager to the macro-economist think tank – it seems to be impossible to find an opinion that differs from the view infrastructure investment is much needed, out there and can only get bigger.
Take James de Bunsen, manager of the Henderson Alternative Strategies Trust, “Everyone is agreed that new infrastructure and new bouts of upgrading are 100 per cent needed.”
He actively manages a fund of £110m, only a small part of which is infrastructure, and that’s a tiny number.
According to McKinsey & Co’s 2017 Infrastructure Report we spend on the broad spectrum of infrastructure – energy, transport, water, healthcare and so on – a bit less than US$10trillion around the world every year, equivalent to roughly £280bn a day.
Yet there is a massive shortfall in funding of at least $800bn. Every year.
Another set of calculations produced in 2015 by the leading economic think tank, David Hale Economics, estimated the global stock of infrastructure will double to more than US$110trn over the next 12 years.
Nick Langley – co-founder of RARE, an Australia-based specialist infrastructure fund manager says:
“Infrastructure is an asset class that is in a multi-decade secular growth phase. Estimates vary, however they all point in the same direction – the global stock of infrastructure assets is set to expand greatly over the coming years.”
OK, but why the shortfall – where is the money?
Langley says the expansion will be driven by growth in emerging and developing markets while the upgrading of infrastructure in developed economies will need to be matched by funding for future projects.
“Alongside this, as government balance sheets have become stretched across the world there has been a focus on fiscal consolidation – with limited appetite for government investment in large-scale infrastructure projects,” he says.
Helpfully, David Hale Economics produced a chart which shows all we need.
Yet while the need is universally acknowledged, the delivery is very different.
There is, he adds, an increase in the provision of funds by the private sector leading to significant growth within the listed infrastructure asset class.
Is this ineffective?
But yet, it doesn’t seem to be very effective.
While, as de Bunsen says: “We are certainly in the UK in the middle of an infra upswing the asset class remains very niche.”
And when funds do invest they tend, with very few exceptions, to pile exclusively into ‘already operational’ assets like toll roads and bridges, energy pipelines and hospitals. The financial institutions around the world don’t do risk, it seems, they pay someone else to do that and are consequently prepared to accept very low yet steady returns.
“It is changing slowly, there are huge managers coming into the sector with big sums of money but at the end of the day infra funds are bought by people who like Unilever because everyone will always want toothpaste,” he adds.
This attitude seems to have pervaded the asset management industry right up to the pension funds who are widely perceived to be on the missing list when it comes to investment in infrastructure, even though there has been a recognised turnaround in outlook in recent years.
Blisteringly critical
In a blisteringly critical article in the Financial Times in July 2017 professors of finance and business school directors Noel Amenc and Frederic Blanc-Brude accused active asset managers and listed infrastructure investments of being ‘fake’.
They say: For the past 15 years, infrastructure investment has been the preserve of large sophisticated investors. It is rapidly becoming more mainstream, and asset owners of all sizes are considering investing in it.
Originally confined to private equity or debt strategies, the label “infrastructure” can now be found on numerous financial products.”
They say ‘not all’ products add value to the portfolio of an institutional investor.
“The investment beliefs associated with infrastructure are rooted in a strong economic narrative. But this intuitive story is being used to sell different things. In particular, the fast-growing listed infrastructure sector is shown by peer-reviewed academic research to offer zero additional value to an institutional portfolio.
“We call this fake infrastructure.”
Fiscal crisis
The first listed infrastructure find – HICAL, was launched in 2006 – and by the end of that year there were nine. The asset class really took off beyond the fiscal crisis of 2008 because, as James de Bunsen has already said, there was an immediate demand for a very low-risk, low return reliable investment class.
Ten years later that had risen to 66 and 32 Exchange Traded Fund (ETF) indices and at the time of writing there are 17 index providers who publish more than 25 listed infrastructure indices. Of all those that refer to listed infrastructure – the professors counted more that US£50bn assets under management.
“Our research shows that listed infrastructure equity does not have a better risk-adjusted performance profile than the market index; does not exhibit downside protection characteristics; does not improve portfolio diversification; is replicable using traditional asset classes; and is also replicable using standard risk factors.”
As Nick Langley of RARE reminds us balance sheets the world over are stretched and under fiscal constriction and this combines with a lacklustre appetite among governments for large-scale infra projects this leaves the private sector.
Yet it would not have a taken a wild stretch of anyone’s imagination to think that the massive pension funds might want to get involved. After all, they themselves manage some really very impressive numbers and require relatively low-yield and highly reliable long-horizon investments.
Changing attitude
They have by many accounts been slow to the game even though there is gathering evidence that this attitude is changing.
For one recent example, in the last year it was revealed that London’s £4.2bn ‘super-sewer’ – aka the Thames Tideway – is being backed by several UK pension funds.
After all, says Edi Truell former chairman of the London Pension Funds Authority, “Pension Funds are natural investors in infrastructure.”
UK Government reforms of pension fund rules to allow further infrastructure investment have long been touted for inclusion in the Budget – but as yet no luck.
According to data provider Prequin by 2016, British pension funds had an average of 3.6 per cent of their assets invested in infrastructure, up from 3.2 per cent in 2010.
Over the next three years, 73 per cent of senior pension fund professionals say they expect schemes to increase their allocation to infrastructure, according to a survey by First, which organises events for institutional investors. In comparison, only 38 per cent of the 45 pension officials polled said the same about investing in property.
So where have they been?
“It is a misnomer that UK pension funds don’t invest in infrastructure. That is not true. They do.” Says Duncan Hale, global head of infrastructure at Willis Towers Watson.
He adds that one of the biggest issues institutional investors face is that there is often a lack of clarity over so-called “funding” — the rate investors will be paid, or the yield they will receive, once the project is built.
“There is more than enough capital chasing deals. There are no problems finding the financing for deals,” says Hale. “The reason a lot of projects are not being built at the moment is because they are not properly funded.”
There then is the nub of the issue. We have increasing appetite among the private investment community both retail and institutional for infrastructure.
Everybody knows more is needed in both regeneration and fresh investment into infrastructure.
But yet the funding gap remains and apparently gets wider all the time.
The time is right then for a fundamental rethink of infrastructure finance.