Infrastructure typically refers to facilities and structures that are critical for orderly and productive functioning of the economy. Examples include transportation assets (such as roads, airports, ports, bridges and rails), utility and energy assets (such as power generation, electricity distribution, gas networks and fuel storage facilities), communications infrastructure (such as Internet connectivity, transmission towers, etc.) and social infrastructure (such as education, recreation, waste management, healthcare, etc.).
The source of financing for infrastructure projects varies from government spending to foreign aids and private sector capital. With increased budgetary constraints across many governments around the world, private investment in infrastructure is playing a progressively critical role in the global infrastructure finance space. This edition of FMDQ Learning focuses on how infrastructure constitutes a strategic investable asset class in the debt capital markets.
An asset class is a group of investment securities with similar financial characteristics, and are often governed by comparable laws and regulations. Examples of traditional asset classes in the capital markets include fixed income and money market securities, equities (or stocks) and derivatives. Other examples include tangible assets such as real estate, commodities, infrastructure, amongst others. Infrastructure, as an asset class, delivers essential services to the economy, whilst offering reliable long-term cash flows to investors.
The fundamental appeal of infrastructure assets to investors are the predictable cash flows, derived from long-term contracts with the government or blue-chip counterparties; the inherent protection from competition that comes with natural monopolies; concession agreements with public authorities; and the strategic importance of the assets to the economy. Infrastructure assets are typically well-suited to pension funds, insurance companies, sovereign wealth funds, and other long-term oriented investors as they offer long-term stable returns to match the long-term liabilities.
They also offer the advantage of portfolio diversification, coupled with an opportunity to improve the overall risk-return profile of portfolios due to their low correlation with other asset classes. Also, Infrastructure assets provide reliable inflation-linked returns and an opportunity for value enhancement through active management of the assets, creating smoother and more predictable returns on investments. Infrastructure as a relatively new asset class has several distinct and attractive investment characteristics.
Unique Characteristics of Infrastructure Assets
Infrastructure assets often have high barriers to entry and near-guaranteed demand (through purchase agreements) which protect them from competition, ensuring that their financial performance is less sensitive to economic cycles. In addition, these assets offer long-term, stable and predictable cash flows, and a pricing model that takes care of any potential inflation. These characteristics serve to ensure that investors have long-term, low-risk, inflation-protected and noncyclical
returns.
Some of the economic characteristics include high barriers to entry, economies of scale (e.g. high fixed, low variable costs), inelastic demand for services (offers essential services), low operating cost and high target operating profit margins, long tenors (e.g. concessions of 25 years, or leases of 99 years), etc. On the financial side, some of the characteristics include attractive returns on investment, low sensitivity to swings in the economy and markets, low correlation of returns with other asset classes, long-term, stable and predictable cash flows, good inflation hedge, natural fit with long-lasting, often inflation-linked pension liabilities, low default rates and opportunities for socially responsible investing.
Infrastructure Investment Instruments/Channels
To promote investments in infrastructure assets, a growing number of specialist products have been developed in the capital markets to satisfy the demand for infrastructure as a new asset class. Investment in infrastructure can generally, be made in various forms – from direct infrastructure investment to creation of infrastructure funds.
Some of the investment vehicles are discussed below:
Direct Infrastructure Investment:
This is the direct investment of huge financial resources in infrastructure projects by the private sector, particularly institutional investors looking to invest directly in infrastructure rather than committing to pooled funds. Investors with huge capital base could seek direct infrastructure investments to gain closer control over the assets held in their portfolios. This also allows the investors to hold infrastructure assets over the long-term rather than being restricted to the lifespan of an infrastructure fund. Private equity investors typically could make direct investment in infrastructure assets (through equity
investments)
- Infrastructure Funds: Infrastructure funds could be listed or unlisted. Listed infrastructure funds are specialized funds that invest primarily in direct infrastructure projects, public or private infrastructure companies or securitized debt securities of infrastructure companies. Such investments typically offer the benefits of infrastructure exposures with lower cost, greater liquidity, and diversification. Infrastructure funds can be listed and traded on an organized securities exchange such as FMDQ. An example of an infrastructure fund currently listed and trading on FMDQ is the ₦5.00 billion closed-ended Chapel Hill Denham Nigeria Infrastructure Debt Fund (NIDF), which is the Series one (1) of its N200.00 billion Infrastructure Debt Fund Issuance Programme. On the other hand, the unlisted infrastructure funds into which private equity investors invest, could either be open-ended (funds that are bought and sold on demand, and do not limit unit of shares it can offer) or closed-ended (funds with a fixed number of shares, traded amongst investors on an exchange). Private equity investors could also make an indirect investment in infrastructure (through infrastructure funds) on behalf of their partners.
- Infrastructure Bonds: A bond is classified as an infrastructure bond (also called a project bond) if it meets all of the following criteria.
i. Issued to finance a specific infrastructure project
ii. Capital raised from the bond is repaid from the cash flow generated by the project
iii. Bond assumes (and its performance is subject to) the specific risk associated with the project it finances
iv. Issued by a project-operating company (typically a government parastatal, Special Purpose Vehicle or a corporate entity) with investment grade credit rating
Infrastructure bonds are usually long-tenured, with maturities ranging from ten (10) to twenty (20) years. They often come with credit guarantees (such as partial risk guarantee from the government) to de-risk the associated project(s) and are listed and traded on securities exchanges (such as FMDQ). Infrastructure bonds offer relatively higher risk-adjusted yields, hence constituting an attractive investment alternative to portfolio investors and pension funds administrators. Long-tenured funds in the financial sector (particularly pension funds and insurance companies’ funds) are attracted to infrastructure bonds, given that they are
relatively cheap, and could be used to match longer-term liabilities.
Though not exhaustive, other investment products available in the infrastructure space include infrastructure fund-of-funds, exchange-traded funds (ETFs), passive funds, and some derivatives which are built around various listed infrastructure indices. For example, ETFs are funds that track market indexes (such as the S&P Nigeria Sovereign Bond Index, and are listed on organized exchanges). In this regard, an infrastructure ETF which is designed to track market indices of
companies that make investments in infrastructure projects can be listed and traded on organized exchanges such as FMDQ.
Risk Considerations
Whilst infrastructure assets are generally considered as being a relatively low risk, they are exposed to a number of infrastructure-specific risks, some of which include demand risk, regulatory risk, credit risk, operational risk and financing risk.
- Regulatory risk is critical to infrastructure projects since they are regulated by government policies and long-term concession agreements which could threaten asset performance
- The long-term nature of infrastructure projects exposes counterparties to credit risk, even as the risk of project failure (operational/construction risk) is prevalent in greenfield (new) infrastructure projects
- Some infrastructure assets (especially transport assets such as roads, airports, ports etc.) are exposed to usage or patronage risk which could negatively impact the expected cash flows from the assets
These risks are often mitigated through a web of contracts that typically seek to transfer the risk to counterparties that are best-suited to manage such risks. It is pertinent to note that whilst infrastructure bonds are indirectly exposed to the above-listed risks, a major risk consideration for an investor holding this is the issuer’s risk, i.e. the credibility of the institution offering the bonds. Ideally, if an issuer is considered to have incompetent management, poor credit ratings, a history of failed infrastructure projects and poor corporate governance, bonds issued by such issuer are considered risky. To mitigate this risk, investors typically go for infrastructure bonds that are issued by institutions with investment-grade credit ratings (such as AAA, AA+, AA, and AA- ratings).
Infrastructure is unarguably seen as the key to unlocking economic development across the world. By expanding an economy’s production and consumption possibilities, private sector investments, job creation and improved standards of living are facilitated. The Nigerian capital markets play a key role in crowding-in private sector funding for infrastructural and economic development through the provision of credible and reliable structures to support the development and use of infrastructure instruments. FMDQ, on its part, is at the forefront of using the capital markets and opportunities therein to unlock capital to support economic development. This constitutes a key strategic initiative for the OTC Exchange in the coming year, and with the concerted efforts of all stakeholders, should
materialize favorably.
