Why invest in infrastructure

What is infrastructure investing?

Infrastructure is an asset class that falls under the umbrella of alternative investments. It is typically considered in an overall portfolio context, alongside other alternative or private-market asset classes such as real estate and private equity.

Infrastructure refers to the basic systems and services that are necessary for a country to function effectively. 

Traditional sub-sectors include utilities such as gas, water, and electricity networks; transportation such as airports, toll roads, railways, and seaports; social infrastructure like hospitals and schools; and energy infrastructure such as power plants and pipelines. 

Newer sub-sectors have also emerged and become mainstream. Examples are digital infrastructure — the likes of data centres, fibre optic networks, and telecommunications towers — as well as energy transition infrastructure, such as renewable energy and energy storage facilities.

Infrastructure investments generally have the following characteristics: inelastic demand, relatively stable cash flows, low volatility, and low long-term exposure to commodity prices.

There are several ways for investors to obtain exposure to infrastructure, under the two broad categories of equity and debt:

Equity:

• Shares of listed infrastructure companies on public stock exchanges
• Unlisted equity investments in infrastructure projects or companies via funds (such as unit trusts) in the private markets
• Direct investments or co-investments in specific infrastructure projects or companies

Debt:

• Infrastructure corporate bonds (a subset of the broader corporate bond universe)
• Private infrastructure loans through funds
• Private infrastructure loans through direct lending

Key stages of infrastructure projects

In the infrastructure sector, project development essentially goes through three phases: greenfield, brownfield, and secondary stage. Investments may be made at any of these stages.

1. Greenfield

A greenfield asset or structure does not currently exist, so it has to be designed and built. Investors finance the development and the maintenance once it is operational. Greenfield projects tend to be riskier because of the uncertainty as to demand and pricing, as well as the costs required to plan and develop the assets.

The main risks are construction, regulatory, and execution risks, as well as possible capital expenditure overruns.

2. Brownfield

A brownfield asset or structure has been built, and is usually at least partially operational. It may also already be generating revenue. That makes it generally less risky than greenfield projects, as there are less or no start-up costs.

Where investors come in would be if the infrastructure asset requires improvements, repairs, or expansion. Ongoing capital expenditure may be necessary.

3. Secondary stage

Secondary-stage assets are fully operational and do not require any investment for development. They are already generating cash flows and returns, which makes them a lower-risk investment than greenfield and brownfield projects.

How to gain exposure to infrastructure

Infrastructure projects may be funded in a few ways: publicly — by the government, for instance through taxes; privately — with private capital, from investors; or through public-private partnerships.

Infrastructure investments can be made through unlisted funds, listed funds, or direct investments. Most of the infrastructure funds are closed-end private funds, generally with terms ranging from 10 to 15 years with several one-year extensions, although longer terms of 20 or 25 years are also available.

Meanwhile, the publicly-traded vehicles are traditional open-end funds whose share prices fluctuate daily.

Depending on their sectoral focus and strategy, many private equity funds and private credit funds could have some exposure to infrastructure. There are also specialised infrastructure funds, which invest only in infrastructure assets or private companies that take on infrastructure projects.

What are the key investment strategies?

Infrastructure investment strategies can be categorised into core, core plus, value add, opportunistic, and debt. The first four types are focused on equity investments. 

Each strategy is located at a different point of the risk-reward spectrum, depending on the underlying assets. The expected return increases as we move from core to opportunistic.

Infrastructure risk and return:

1. Core

This strategy is considered the most stable form of infrastructure equity investing, because the assets are essential to society, have no operational risk, are already generating returns, and command a monopoly position. Returns are generally derived from income, and the holding period may be more than seven years, according to Mercer's estimates.

They tend to be secondary-stage or brownfield assets, and have long-term stable cash flows. Revenues are governed by long-term contracts with highly creditworthy counterparties, such as governments in developed countries with transparent regulatory environments.

The typical infrastructure sub-sectors for core strategies include utilities (gas, electric, and water), renewable power generation, as well as mature, top-tier airports.

2. Core-plus

This strategy targets assets in undeveloped markets, but with little-to-no construction risk. They are similar to core infrastructure in most ways, except that core-plus assets may have more variability in their cash flows and may be more sensitive to the economic cycle and fluctuations in demand.

The overall returns still include income as a component, but there is also greater scope for capital appreciation, as compared with core assets. The holding period is usually more than six years.

Examples of core-plus infrastructure are contracted oil-and-gas midstream assets, and toll roads or airports that are more sensitive to economic growth.

3. Value add

This is a moderate-to-high-risk strategy targeting assets that are less monopolistic and require expansion or repositioning. The focus is on adding value by growing demand for the asset, which is often greenfield or brownfield. Returns are mainly from capital appreciation, instead of ongoing income. The holding period may range from five to seven years.

Typical sub-sectors for value-add strategies include data centres and fibre optic networks, as well as early-stage oil and gas midstream assets.

4. Opportunistic 

This is the riskiest but also has the highest return potential among the five strategies. Opportunistic infrastructure projects could be under development, located in emerging markets, highly exposed to commodity prices, under financial distress, or in need of major repositioning. Returns are almost entirely from capital growth in the value of the underlying asset. Holding periods are shorter, typically around three to five years.

5. Debt

Investors can also finance infrastructure projects by organising or acquiring loans that are secured by those assets. The type of debt will affect the risk exposure of the investment strategy. As Preqin notes, most infrastructure assets are funded by senior loans and have simple capital structures; they therefore tend to be relatively low risk.

Types of infrastructure investments

How infrastructure investing adds value to your portfolio

Infrastructure assets are generally seen as low-risk, long-term investments, and can be an important component of a long-term investment portfolio. 

They are meant to provide stable, strong risk-adjusted returns across a broad variety of economic conditions and regions. Adding infrastructure assets to your portfolio can also offer asset-class diversification benefits, an inflation hedge, downside protection, as well as income and/or capital appreciation — depending on the chosen investment strategy.

Such assets often have a regulated and contracted revenue model and are non-cyclical in nature. That’s why they are able to generate reliable and steady cash flows. For instance, a newly-built water management system may be contracted by the government to run for the next decade; that allows for predictable cash flows over the long run.

Investors' main reasons for investing in infrastructure assets:

Infrastructure is also a non-cyclical sector, which means they are less volatile to economic and market cycles. Assets such as hospitals, roads, and sewage systems will still be heavily used even during an economic downturn. 

Further, they have a low correlation to the wider market — cash flows from infrastructure assets are generally less correlated to other asset classes in a standard portfolio, such as publicly traded stocks and bonds, especially over the long term. That means including infrastructure in a portfolio can help reduce overall portfolio risk and bring diversification benefits. From 2008 to 2021, the equity performance of global instructure assets had a correlation coefficient of -0.1 to both global bonds and equities, according to J.P. Morgan Asset Management’s calculations based on quarterly total returns. 

Because infrastructure provides essential services, many of the contracts are indexed to inflation, allowing the prices to rise in line with, or above, inflation rates. That offers a long-term hedge for investors who are concerned about high inflation in the future.

The chart below shows the performance of private (unlisted) infrastructure equity, as compared to developed-market stocks, in different inflation and economic environments. Both private infrastructure and public equities perform well when gross domestic product (GDP) growth is strong. However, infrastructure assets stand out especially when inflation is high — outperforming public markets. 

Finally, investors may contribute to a better, sustainable future through infrastructure investments. There are funds that focus on sectors such as renewable energy or social infrastructure, enabling investors to generate attractive returns while making a positive social and environmental impact.

Note that the infrastructure investment universe spans a very wide range of strategies when it comes to the levels and types of risks, as well as the return potential and correlation.

What to consider before allocating to infrastructure

If you’re thinking of investing in unlisted infrastructure equity, an allocation will require additional time and resources from the investor, as with all private-market investments.

Note also that greenfield and brownfield projects are often capital intensive, given the large costs involved in the planning, building, and development stages.

In certain cases, especially for direct investments, infrastructure investments can be highly illiquid. That being said, the extent of any liquidity constraints will depend on the investment strategy and the fund structure. To manage illiquidity risk, investors should have a long-term strategy and maintain appropriate levels of liquidity on a total portfolio basis.

Other factors to take into account include potential environmental, social, and governance (ESG) risks. Not all infrastructure assets are ESG investments — for example, building a major highway or bridge may disrupt the community living in that area, or the construction of a greenfield project could lead to pollution or other environmental hazards. Many infrastructure projects have a large environmental footprint, and most have a direct social impact.

Investors should also consider the political and regulatory environment. Infrastructure assets are subject to laws and regulations, and non-compliance can result in fines and restrictions. Depending on the geographical region, the government’s stance on developing, funding, and regulating infrastructure will also vary. Assets in emerging markets may face a higher political risk or a higher likelihood of revenue volatility than in developed markets. 

Start your infrastructure investing journey with Endowus

One way to approach infrastructure investing is through the core-satellite method. The smaller, satellite allocations of your portfolio can include infrastructure and other alternative investments such as hedge funds. These will then complement your portfolio’s largest, core component, which should be globally diversified, have a strategic passive asset allocation, and come at a low cost.

An example of a satellite allocation that gives infrastructure exposure is the Endowus Real Assets Portfolio. This is a curated and well-diversified portfolio of best-in-class funds, managed by experts such as Janus Henderson Investors, KBI, M&G, Ninety One, Nordea, and PIMCO.

You may also wish to invest in single funds via the Endowus Fund Smart platform — the funds available can be filtered by the equity sector, which includes infrastructure. 

Endowus keeps fund-level fees as low as possible by working with fund managers to access their lower-fee share classes and with our industry-first practice of rebating 100% Cashback on trailer fees to our clients. For more information on our transparent fees, follow this link.

Endowus has a private wealth arm that provides access to more investment products, including alternative investments such as infrastructure assets. With Endowus Private Wealth, clients looking to invest a minimum of S$1 million in assets across our services can gain exclusive access to more personalised solutions and products.

Let us introduce you to a better way to manage your wealth. For more information on Endowus Private Wealth and infrastructure investing, please contact us for a consultation.

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