The TEXPERS Blog

Investors to continue infrastructure 

investment increases next year

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Transportation infrastructure is one of several infrastructure investment frameworks. Transporation infrastructure includes roads, railways, ports and airports.

By Declan O'Brien, Guest Columnist

Infrastructure is increasingly attracting institutional investors drawn by regulatory change and yield. 

Infrastructure is broadly defined as physical structures that provide or support essential public services in these categories: utility and energy, transportation-related, communications and social infrastructure. Since 2012, institutional investment in infrastructure has about doubled to 1.1 percent of assets under management, according to the Annual Survey of Large Pension Funds published in 2015 by the Organization for Economic Co-operation and Development. And, according to asset industry data source Preqin, 89 percent of infrastructure investors surveyed in 2017 planned to maintain or increase their allocation over the next year.

Institutional investors have been very active in larger infrastructure transactions, according to industry figures. The average size in 2016 was $282 million. However, banks continue to dominate the mid-cap area where the highest volume of transactions was, in 2016, more than 54 percent of the deals in the private market, totaling less than $124 million. This mid-market space could present opportunities for institutional investors.

Here are some key attractions of infrastructure debt:

• Infrastructure debt is lower risk than equivalently-rated corporate, or non-financial corporate, debt, according to default and recovery studies by Moody’s. The studies show that at the BBB rating, the 10-year expected loss rate of infrastructure debt is less than half that of corporate debt (see graph). These lower losses mean that infrastructure debt provides superior net spreads (actual return experience) versus equivalently-rated corporate debt with the same gross spread. 

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• It has duration and premium over public corporate bonds. Infrastructure is capital intensive and typically has a long expected useful life, supporting long-term debt. Coupled with the stable business risk, it can provide an effective duration for liability-matching investors. Inflation-linked debt could further benefit liability-matching schemes. Private infrastructure debt provides a premium over public corporate bonds. This premium is compensation for the illiquid nature and the complexity of the investment, where transactions typically require structuring expertise and an understanding of the asset specific risks.

• Infrastructure debt can act as a diversifier to other credit. The defensive and low correlation with other asset classes of infrastructure should result in more stable cash flows than corporates. Moody's 5-year migration rates show the higher rating stability of infrastructure issuers versus corporates. Also, the one-year rating migration rate for corporates was 23 percent more volatile than infrastructure over the study period, according to Moody's.

There are some key risks of investing in infrastructure debt, including:

• Revenue risk. There is a range of revenue structures within the infrastructure asset class, including availability-based revenues (where you are paid for keeping the asset available) and user paid, which subjects investors to demand risk, and is most prevalent in transportation and energy projects. If the asset provides an essential route or is critical to energy security in that region, this can act as an important revenue stabilizer.

• Regulatory and sovereign risk. Infrastructure assets are often heavily regulated, thus exposing them to an element of political interference and requiring careful evaluation of regulatory issues in the investment process.

• Contractual and credit risk. Contractual protections are an important feature of infrastructure transactions. In sectors where the demand for, or the price of, the output is uncertain, these contracts - if provided by creditworthy counterparts and are not on substantially off-market terms - can significantly reduce these risks.

• Construction and operational risk. Greenfield projects involve construction risks, though such risks can be mitigated through structuring (for example, by passing risks to a competent and creditworthy contractor) supported by performance supports and liquidity to cover delays and cost overruns. Failure to perform could result in heavy penalties or, in certain scenarios, a loss of license or concession.

Infrastructure assets are typically levered at around 75:25 debt:equity. The case supporting high leverage is the essentiality of the asset and stability of cash flows. However, given the range of revenue risk profiles, it is important to size debt levels appropriate for the risks around revenue stability. Similarly, structures that contain an element of refinancing, inflation, currency or interest rate risk should be appropriately hedged to be able to withstand downside stress scenarios.

The economic and social benefits of infrastructure position the asset class well to make a positive impact with respect to economic, social and governance investment. However, each investment needs to be considered on its own merits. The climate change implications of an investment are central to this analysis. 

Infrastructure assets can be low-risk and demonstrate low correlation as well as possibly offer an additional premium for private infrastructure. Infrastructure assets may also provide social and economic benefits to their communities, all of which increase the appeal to institutional investors.

The views expressed do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of TEXPERS. The views expressed are as of March 2018 and are a general guide to the views of UBS Asset Management. Information and opinions have been provided in good faith and are subject to change without notice.

Declan O'Brien

About the Author:

Declan O'Brien is a senior infrastructure analyst in the research and strategy team, which forms part of Real Estate & Private Markets within UBS Asset Management. O'Brien joined UBS-AM's business in October 2017. In this role, he is primarily responsible for providing quantitative and qualitative cross-regional analysis of infrastructure investment markets.