There aren’t many investment opportunities to be found in a global economy sliding towards depression, but one of the few areas for optimism is infrastructure – roads, dams, power plants, ports… that sort of thing.
US president-elect Barack Obama says that, as part of the plan to combat recession, his administration will make the largest investment in the nation’s infrastructure since the interstate highways network in the 50s, to “save or create” 2.5 million jobs. That could easily require spending more than a trillion dollars.
Other countries have similar splurges in mind.
China’s $600 billion plan to boost the economy will largely focus on infrastructure. In the current quarter, four-fifths of stimulus spending is on public works in rural areas such as sewage incinerators and water-treatment plants, railways and subways, ports and airports, energy-saving and environmental projects, highways and public housing.
Mexico is planning the largest public works budget in its history, equivalent to 6.5% of GDP.
Britain is investing on a scale not seen for a generation in upgrading London’s rail transportation systems, partially in preparation for the 2012 Olympics. Crossrail alone, linking east and west, will increase the city’s public transport capacity by 10%.
Governments like to fight recession by spending on infrastructure because it provides an immediate boost to the economy, and one they can control, shape and push forward, creating jobs and demand for locally-produced materials such as cement, structural steel, piping and cable.
Voters can see that not all their money is being channelled to undeserving bankers or auto companies, but into projects offering their communities real long-term benefits.
However, as with all forms of government spending, such plans create opportunities for abuse by politicians and the corrupt construction business interests to which they are often linked. Japan became notorious in the 90s for the scale of its wastage on public infrastructure projects that had no commercial justification, such as building high-speed railways to thinly-populated areas, and concreting river banks.
In recent years we have seen a boom in the concept of infrastructure as a separate investment class. Cheap and abundant credit reduced the yields on conventional low-risk investments, motivating pension and other long-term funds to look elsewhere.
Infrastructure assets such as toll roads, ports and power stations fitted the bill. They provide stable and relatively predictable cash flows over the long lives of such assets, making them an excellent match for the liabilities of such funds.
The emergence of a new asset class
A whole new investment sector grew up, initially pioneered by Australia’s Macquarie Bank, which bought up existing publicly-owned infrastructural projects around the world and packaged them into funds for selling on to long-term private-sector investors. Over a decade the assets in this class grew from virtually nothing to about $120 billion.
The bursting of the credit bubble has damaged confidence, as funds no longer find it easy to gear up their returns using borrowed money. And there are fears that income streams will no longer be regarded as virtually risk-free as the pain of recession spreads.
In many countries projects such as motorways, bridges, harbour and airports are ‘patronage assets’ that depend on steadily-increasing usage to make returns. With businesses cutting down and fewer people taking holidays, traffic could well fall sharply, threatening income flows from such assets.
Funds based on such existing assets have suffered in the credit crunch because of projects in the pipeline based on the assumption of cheap financing. In September the FT reported that banks were sitting on $34 billion of ‘paralysed’ infrastructure financing for projects such as airports and utilities.
Acquirers argued that the monopolistic characteristics of such takeover targets guaranteed stable cash flows that could support large borrowings. In the current environment it has suddenly become very difficult to obtain such cheap financing.
That business model is likely to continue to suffer in this new world of slowdown/slump, with lenders demanding much higher yields for their money.
Opportunities in new projects
There is also ‘regulatory risk’ – that in our new world of anti-capitalism, public pressure will force governments to take less generous attitudes towards what privately-owned facilities may charge.
Nevertheless, we are likely to see a flood of opportunities in new projects, especially in Asia, where so much infrastructure will be needed to service continuing economic growth – even if such growth is less than in the past.
Most of the capital to finance such projects will come from state coffers, but governments will be keen to attract capital from the private sector, too. India, in particular, hopes to raise from that source half the $100 billion a year it plans to spend on infrastructure.
Axel Ritter of UBS Wealth Management in Singapore says: “We have noticed an increasing demand from private investors for infrastructure assets as ageing populations seek longer-term, higher-yielding and defensive assets to fund their retirement incomes.
“These investors seek a risk/return profile somewhere between equities and bonds with a set of cash flows with very long duration, inflation indexation and with a gradually rising coupon rate”.
Karen Tan of Deutsche Bank Private Investment Management in Singapore says the asset class offers inflation protection as, when prices rise generally, “operators of infrastructure facilities are often able to increase prices due to their monopoly market position, thus protecting returns against erosion by inflation.”
There are three ways in which investors can take a stake in this sector:
• In shares and bonds of companies building or supplying materials or equipment for infrastructure construction;
• In mutual funds offering participation in diversified portfolios; and
• Direct investment in non-listed infrastructure projects.
The Swiss bank UBS recently raised more than $1.5bn for a new fund to invest in new projects with lives of 15 or more years. Manager Steve Jacobs says this asset class is “like a stable fixed-income investment with a warrant, giving you ownership exposure on top.”
Its fund aims for an internal rate of return of 10 to 13% a year from projects in stable, well-developed countries.
HSBC Infrastructure Company, listed in London (HICL), invests in long-term projects with 20- to 60-year revenue profiles. Its largest investment is in the Dutch high-speed rail links. Other holdings are in education, utilities, transport, healthcare and public-sector accommodation projects.
There are many other collective funds listed on stock exchanges that focus on infrastructure, including a few exchange traded funds such as iShares S&P Global Infrastructure and iShares S&P Global Water.
When you think equity markets look as if they have bottomed, you may also consider investing directly in companies likely to benefit from the coming boom, such as Siemens, ABB, Areva, Toshiba Heavy, Foster Wheeler, Fluor, W S Atkins, Caterpillar, Granite Construction, URS Corp., Meadow Valley, Astec Industries, Jacobs Engineering, KBR, Vinci, Ferrovial, Insteel Industries, CRH.
In China shares of companies such as Anhui Conch Cement and China National Building Material have soared in recent weeks in response to estimates that the nation’s infrastructure construction plan should add 600 million to the current 1.5 million ton annual demand for cement.
The potential for future investment is clearly huge. The OECD recently projected global infrastructure demand [pdf] at more than $50 trillion between now and 2030. And that is without taking into account additional spending motivated by governments primarily to provide economic stimulus.