Crumbling Infrastructure Offers Mid-Market Investment Opportunities

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Includes: PAVE
by: AllAboutAlpha

Deteriorating infrastructure and potential for investment is the topic of a new white paper by Fiera Capital, a Canadian investment management firm.

Infrastructure is generally understood to involve physical assets that provide a public service, including those most vital to economic development. The category includes water and waste water systems, highways and bridges, power transmission, etc. Aging infrastructure systems are themselves the result of decades of underinvestment in even the developed world. As Fiera's paper observes, the crumbling of these assets "negatively impacts economic growth, social development, and the standard of living."

The American Society of Civil Engineers, in a report published last year, graded the United States a D+ on infrastructure. It said that a lot of investment in the rehab and development of infrastructure will be necessary to support economic growth going forward.

On the plus side, this creates an opportunity as governments contract-out the risks and rewards of investing in these systems.

Fiera focuses its infrastructure operation on the mid-market, which has higher historical return than its large-cap counterpart. The boundary between mid- and large-cap infrastructure projects is an equity investment requirement of $200 million. And well above that, there are the mega-cap projects, with capitalization of $1 billion or more. As Fiera observes, sovereign wealth funds are among the major investors in that range.

Some History

Canadian entities were among the first private investors in infrastructure back in the 1980s. The entities included pension funds, which have large pools of capital and long time horizons, so they need not be bothered by the scale and illiquidity that often come with the field.

Around the turn of the millennium, Australian-based Macquarie Bank floated the idea of a managed infrastructure fund on the model of private equity or real estate funds. The Macquarie Bank established North America's first unlisted infrastructure fund, the Macquarie Essential Assets Partnership ("MEAP"). Alina Osorio, former CEO of MEAP, is now the president of Fiera Infrastructure.

Between 2003 and 2007, European and North American asset managers caught on to the notion that infrastructure is its own asset class. By the end of that period (December 2007), unlisted infrastructure assets under management worldwide had reached $99 billion.

The financial crises of the following year hampered the ability of a number of countries to raise debt for use to renew their infrastructures, thus "exacerbating the infrastructure deficit issue."

Environmental considerations are now one of the driving factors in the infrastructure market. Concern over greenhouse gases and related issues is expected to lead to the construction (and, of course, the financing) of new renewables facilities and "green energy" plants.

Standard Deviation

The Fiera paper makes the point, using standard deviation as a proxy for risk, that global infrastructure is less risky than global equities. Their standard deviations are 10.5% and 11.3%, respectively. Global infrastructure is correspondingly a lot less risky than small-cap or emerging market equities (which have respective standard deviations of 13.7% and 16.5%).

Why the mid-market? The paper observes that "there is less competition for investments, which has led to more attractive pricing for buyers of infrastructure assets and, correspondingly, higher returns than in the large-cap market."

Fiera cites Preqin's numbers on infrastructure deals: nearly half of them required equity of $100 million or less.

Four Takeaways

Fiera identifies the following four points, which it believes are all defining features of success in this space:

  1. Long-standing relationships. Infrastructure, especially perhaps in the mid-market, is a relationship business - relationships are critical for origination and execution as well as for asset management.
  2. Thorough deal screening. Facing a "high number of ongoing and new potential transactions," investors require a structured process for their analysis and assessment.
  3. Prudent risk management. The early identification of a project's major risks is critical to success, as is an institutionalized understanding of risk mitigation.
  4. Active asset management. The management team must be in a position to monitor an asset continuously throughout its lifecycle, including: the partners' financial strength, the investment's risks, review of contractual obligations, the solution of technical challenges and the "identification of upside opportunities."