Infrastructure Investments

Infrastructure investments consist of real, long-lived, and capital-intensive assets. They provide essential services to the public. Examples include airports and healthcare facilities.

Infrastructural investments have increased due to demand-side growth as well as supply-side growth. Many investors are investing in infrastructure as part of demand-side growth. Meanwhile, government investment opportunities create supply-side growth. This is done by increasing infrastructure financing as well as the privatization of some services.

Characteristics of Infrastructure Investments

• They have a highly leveraged financial structure. The use of leverage improves investor returns.
• Infrastructure investments are usually strategically significant.
• Investments in infrastructure are usually monopolistic and regulated. Consideration of regulations such as ESG (Environmental, Social, and Governance) is common.
• They have steady long-term cashflows, adjusted to reflect economic growth and inflation.
• Infrastructure investment involves significant capital investments.
• By definition, infrastructure investments have long operating lives.
• They have well-defined risks.

Types of Infrastructure Investments

Infrastructure investments are classified based on the underlying assets. From a broader perspective, infrastructure investments are classified as follows:

• Social infrastructure assets.
• Economic infrastructure assets.

Economic infrastructure assets reinforce economic activity and include three types of assets:

1. Transportation assets: such as roads, bridges, tunnels, and airports.
2. ICT assets include databases, broadcasting systems, and information-transmitting assets.
3. Utility and energy assets: that generate power and produce potable water.

Social infrastructures focus on human activities such as education, healthcare, and correctional facilities. Social infrastructures are usually administered by a public authority or private institution established by the same public authority.

Infrastructure investments can also be classified according to the underlying asset’s development level. Under this category, we have greenfield investment and brownfield investment. Greenfield investment defines investments in infrastructure assets that are yet to be built. Brownfield investing is used when investing in existing infrastructure assets.

Moreover, infrastructure can be grouped according to location. The risks associated with infrastructure investments are determined by the underlying assets’ geographical location and macroeconomic factors such as government intervention.

Forms of Infrastructure Investments

Infrastructure investments can assume several forms, impacting liquidity, cash flow, and income streams. Investment in infrastructure can take the form of direct or indirect investments.

Investing directly in the underlying assets provides oversight. It, however, involves huge capital investment and attracts concentration and liquidity risks, given that assets ought to be managed and operated.

Indirect infrastructure investment involves investment vehicles such as infrastructure funds, infrastructure ETFs, and company shares.

Risk and Return Characteristics

Return

There is an imminent risk in infrastructure development that the revenues may diverge from expectations. Moreover, investment in infrastructure usually involves leverage. This occasions financial risk.

Low-risk infrastructure investments usually yield steady cashflows and higher dividend payout ratios. The downside is that infrastructure investments have less growth potential and are expected to provide lower returns.

Risks

In infrastructure investment, there is an imminent risk that the revenues may diverge from expectations. Moreover, investment in infrastructure usually involves leverage; therefore, financial risk.

There are three main risk-return profiles of infrastructure:

1. Early-stage investments: These are investments in greenfield projects. While they have a high-risk profile, they also have higher return prospects.
2. Mid-stage investments: These are investments in existing projects. They also have high return prospects. However, compared to early-stage investments, their return prospects are lower.
3. Late-stage investments: These are investments in projects that have existed for a couple of years. Their returns are mainly from yield.

Risk Management

There are two main types of risks in infrastructure investments: performance risks and structural risks.

Performance Risk and its Management

• Demand/volume risk: Payments are based on the availability of an asset instead of its use.
• Operational risk: Engage respected contractors in operation and maintenance contracts and give them incentives to meet agreed-upon performance requirements.
• Construction risk: To reduce construction cost overruns and delays, enter into fixed-price time-certain contracts with credible and competent contractors.

Structural Risk and its Management

• Financing/interest rate risk: Use interest rate swaps.
• Regulatory risk: Perform proper due diligence and ensure contract provisions that govern this risk are clear.
• Political risk: Invest in political risk insurance to be protected, when necessary, from occurrences such as expropriation, political unrest, and sovereign debt default.
• Currency risk: Make that agreement include suitable mechanisms to allow tariff adjustments in case of significant currency fluctuations.
• Tax/profit repatriation risk: Make sure that agreements have proper mechanisms in place to allow for a tariff adjustment and/or other compensation in the event of major changes to the legislation or regulations affecting tax and profit repatriation.

Diversification Benefits of Infrastructure Investment

One of the aims of infrastructure investors is to earn steady long-term cashflows that reflect the effects of economic growth and inflation. Moreover, they may be seeking capital appreciation. As a result, infrastructure investments generate additional income streams and increase portfolio diversification since they have a low correlation with existing investments.

Question

Which of the following is least likely a characteristic of infrastructure investments?

1. Long operational lives.
2. Stable long-term cashflows.
3. Low-leveraged financial structure.

Solution

The correct answer is C.

Infrastructure investments are usually highly leveraged.

Characteristics of infrastructure investments include:

• Highly leveraged financial structure.
• Defined risks.
• Long operational lives. (Option A.)
• Significant capital investments.
• Stable long-term cash flows. (Option B.)
• Monopolistic and regulated.
• Strategically important.