Robin Bowie, founder of Dexion Capital, a boutique investment bank focused on alternatives, adds: “In an environment of increasing inflation, infrastructure can experience stable or increasing prices. ‘Can’ is the operative word here because inflation may be driven by different sources such as labour, raw material or energy shortages, or too much money being printed. The advantage of infrastructure assets is that they provide investors with cash flows and an inflation link which conventional bonds do not. However, inflation linkage is not always explicit and different drivers – tariffs, pricing power, and replacement value – will determine the inflation sensitivity. The key is to understand the sources and level of inflation sensitivity of the infrastructure assets they invest in.”
Toby Buscombe, principal and senior infrastructure specialist at Mercer Investment Consulting, echoes these sentiments. “Infrastructure as a real asset is intended to provide dependable and stable cash yield, as well as some degree of inflation protection. However, it is not homogenous which is why choosing the right type of asset is key. For example, monopolistic assets such as utilities are the best as they have pricing mechanisms that are directly linked to inflation.”
Sectors that fall outside the government sphere such as private public initiatives, toll roads, airports and waste management, have the ability to pass on higher costs but are more vulnerable to the vagaries of the economic cycles and demand.
“These projects have many more risks such as operational, demand and GDP which can offset the link with inflation,” says Keith Kelsall, client portfolio director – infrastructure & real estate debt at Aviva Investors. “Take Heathrow, over time profits could increase but there is no direct tie to the retail price index (RPI). Traditional government-backed as well as renewable energy projects that have feed-in tariffs or monopoly assets are much better, but investors have to look carefully at contracts to see if they stipulate an inflation connection.”
Debt and equity
Just as with the private realm, the public markets of debt and equity also offer different variations on the inflation theme. For example, the Lazard Global Listed Infrastructure Equity fund, employs what it calls a “preferred infrastructure” philosophy which seeks out companies which own physical infrastructure assets that have revenue certainty, profitability and longevity, according to the fund’s manager Bertrand Cliquet. They typically provide a contractual inflationlinkage in cash flows, stable returns through economic cycles, a low risk of capital loss, ‘rising coupons’ through real earnings growth, and diversification due to low volatility and correlations to other asset classes.
“The key risks are political, such as Bolivia recently nationalising its electricity industry, and regulatory which is why we look for companies that are protected by a legal framework,” says Cliquet. “There is also market risk but we have found this to be short term in the eight years that we have been running the strategy.”
James Wilson, head of Macquarie Infrastructure Debt Investment Solutions, is a proponent of infrastructure debt especially for pension funds who are looking to de-risk and match long-dated liabilities. “One of the main challenges is that the public market for RPI-linked bonds has not recovered from the financial crisis. RPI-linked bonds were popular up to 2007 with around £7bn of issuance that year, but since then annual corporate issuance has averaged less than £1bn,” he says. “The problem is not a lack of supply – Macquarie has identified potential issuance of more than £5bn over the next three-to-five years for projects including renewables, PPPs, student accommodation and utilities where borrowers can get comfortable on deliverability. We have started to see the emergence of privately placed deals this year, which is encouraging.”
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