By Gershon Cohen, Global Head of Infrastructure Funds, Alternatives
Today’s markets can be challenging when seeking sustainable yields, but that doesn’t mean investors should give up the search.
Loose monetary policy has been a fixture within the global markets in the years following the onset of the financial crisis. But nothing lasts forever. The U.S. Federal Reserve (Fed) has hiked interest rates four times in the last few years, and other developed-markets central banks have begun to discuss how to put an end to their unprecedented stimulus efforts after witnessing a gradual economic recovery.
For the most part, though, interest rates remain low compared to historical levels throughout a significant part of the globe. This is a particularly difficult challenge for income-oriented investors, and has spurred them to broaden their scope when searching for income-generating opportunities. In this journey to find investments with the potential to provide long-term cash flows, infrastructure may be one of the roads less traveled, but it can offer many attractive benefits.
There is ample demand for infrastructure at this point, driven by a lack of historic investment and increasing mobility, and this trend is expected to continue. According to McKinsey Global Institute, countries will have to spend about 3.8% of gross domestic product (GDP) or $3.3 trillion annually from 2016 to 2030 just to keep pace with the current growth of infrastructure. Sixty percent of the total demand is expected to come from emerging markets.
Appropriately structured, infrastructure investments are able to provide attractive yields to investors over the long term. When an infrastructure project involving both the public sector and private investors begins, contracts are typically put into place for terms of 25 years or longer. These contracts dictate what investors can expect from cash flows once development of the infrastructure asset is complete. A well-managed, stable investment should continue to produce a reliable income stream once an infrastructure asset has been completed.
Of course, infrastructure investments aren’t homogeneous, and countless factors such as timeframes, objectives and governance will vary widely. The ability to generate a revenue stream depends on many characteristics, including the government in charge of procurement and the area where the project is located. For this reason, research into potential opportunities should be conducted thoroughly by an experienced investor/manager. The following questions should be addressed:
- Is the government stable and able to maintain long-term commitments, even as politicians and administrations change over time?
- Is the rule of law commonly accepted?
- How independent are the courts in their enforcement of contract law?
- Is corruption kept to a minimum?
- Are there definite plans for the ongoing operation and maintenance of the infrastructure asset once it’s been built?
One place where many infrastructure investments are meeting these criteria is the Andean region of Latin America. The Andean region is one of the only markets in the world that boasts a sizeable greenfield project pipeline, which can help broaden the opportunity set for existing infrastructure investors. Countries in the Andean region typically have stable governments that are able to commit to projects over the long term. And because there has been little development thus far, it is estimated that there is currently the potential for an additional $40 billion to $50 billion in future opportunities in social infrastructure.
But each country and each investment has its own set of nuances with which investors must be familiar before investing. For investors with limited resources, it can be difficult to conduct the necessary due diligence that can lead to an attractive investment. A professional manager with extensive experience in global infrastructure investing can help locate the projects that are most likely to provide attractive income over the long term.
Today’s markets can be challenging when seeking sustainable yields, but that doesn’t mean investors should give up the search. Instead, they should ensure that they have the right expertise to source these investments and select those that best meet their unique objectives. After all, income-generating opportunities aren’t entirely out of reach, provided you know where to look.
Among the risks presented by PPP investing are substantial commitment requirements, credit risk, lack of liquidity, fees associated with investing, lack of control over investments and or governance, investment risks and tax considerations. PPPs also include political / governmental, operational, environmental, currency fluctuations, differences in accounting methods and project risks. These risks are generally heightened for emerging market investments. Additionally, development, bidding and ongoing costs in PPP projects may be greater than for traditional government procurement processes.