Global Infrastructure – A “New” Alternative Asset Class

Global Infrastructure – A “New” Alternative Asset Class

By Edward Keating, Vice President, Lazard Asset Management

Infrastructure continues to garner increased interest from the global investor community. Pension plans, endowments, foundations, insurance companies, financial institutions, wealthy individuals and investment advisors are among those that are attracted to the long-term, low-risk and inflation-linked profile that can come with infrastructure assets. There is a vast need to improve infrastructure around the world, but due to government fiscal constraints and mounting liabilities, private capital will continue to play an increasingly important role in the financing of and investment in infrastructure assets..

Infrastructure comprises the physical assets that a society needs for orderly operations. They include a variety of assets divided into five general sectors: Transport (i.e., tollroads, airports, seaports, rail), Energy (i.e., gas and electricity transmission, distribution and generation), Water (i.e., pipelines and treatment plants), Communications (i.e., broadcast, satellite and cable) and Social (i.e., hospitals, schools and prisons). These assets can have attractive investment characteristics such as:
1) Diversification benefits: low volatility asset class with diminished correlation with other asset classes,
2) Low risk of capital loss: long term assets with transparent operations and highly visible revenue and
3) Inflation protection: revenues typically linked to inflation.

Shifting Spending Policies

According to the Organization for Economic Co-operation and Development (OECD) governments, including Canada, the U.S., Germany, and the U.K, were spending upwards of 10%-15% of GDP on infrastructure in the 1960’s and 1970’s. More recently, however, OECD governments spent only 2.6% on infrastructure between the years 1991-1997 and a meager 2.2% between 1997-2003. This change in spending policy in the last few decades has created a massive need for nations to refocus investment efforts on infrastructure.

Not all infrastructure assets are created equally, and in order to access the long-term, low-risk and inflation-linked profile that infrastructure can provide, it is critical that investors focus on assets that are characterized by high degrees of revenue certainty (stable demand, monopolistic characteristics, long term, price regulate and inflation linked), consistent profitability outcomes (high operating margins, dividends, distributions, sustainable leverage, appropriate costs structure) and longevity (operate under the developed economic and legal systems found mainly within the OECD). The majority of infrastructure assets actually do not have these preferred infrastructure characteristics and therefore cannot consistently provide the long-term, low-risk and inflation-linked investment profile. Such assets that would not fit the definition typically have significant exposure to commodities, including energy, that do not have monopolistic characteristics like pricing power or high barriers to entry, make use of large amounts of leverage and/or exist outside of the OECD.

A key question facing investors is how to gain access to the asset class. There are three general approaches:
1) The Direct approach is typically utilized by large global pension plans that have dedicated internal resources to invest and manage a collection of directly owned infrastructure assets.
2) The Private Equity approach is typically characterized by highly concentrated investment funds (4-8 investments) that employ large amounts of leverage, require long lead times to invest capital (~5+ years; long client lock-ups) and utilize an asset + incentive fee structure (i.e., 200bps +20% profits).
3) The Public Listed Markets approach is typically characterized by an un-levered, diversified investment fund (25-50 investments representing 75+ underlying infrastructure assets) that utilizes the world’s largest infrastructure marketplace, offer immediate infrastructure access with daily investor liquidity (beta of only 0.5 vs equities) and use basic asset-based fee structures.

Transcontinental Media G.P.