“Hence, see who commits himself eternally” – alternative asset classes are in demand among institutional investors against the background of the low-interest rate phase. The area of infrastructure investments is currently being discussed particularly intensively.
According to various studies, but also according to ongoing reports on this asset class at investment companies and other firms, the asset management industry is engaged in discussing it. The areas in which investments can be made are diverse: Listed Infrastructure, Debt Funds, Real Assets, and Renewables – all topics that promote a fruitful dialogue are welcome to the industry. The opportunities for long-term portfolio management appear promising. The challenges for providers and investors are great. Know-how, risk management, and communication are the focus of providers and investors.
Possible fields of investment in infrastructure investments
Cities must be built, power grids expanded and water dammed: Private and public investors are needed. In addition to the above-mentioned fields, the opportunities for infrastructure investments are broadly diversified. Roughly speaking, for example – without claiming to be exhaustive – the fields of communications (cable, radio), transport (rail, ship, roads), supply and disposal (waste, electricity, water) and social affairs (education, culture, health) can be considered as projects or companies as corresponding investment objects. The seemingly trivial character of this list is deceptive because the investment field (“project financing”) will in many cases be subject to a variety of risks: Regulation, input/output, the role of government and politics as well as operational risks, transfer risks, etc. increase the complexity of decision-making for institutional investors. Despite the “longevity” of investment objects, which is often encountered, it is by no means always possible to speak of safe investments, an impression that can arise during some investment discussions at conferences or in the trade press. Entrepreneurial investment decisions, regardless of packaging aspects, are by their very nature subject to risks that can be successfully managed in many cases. The industry is working on making these risks “investable” for investors in a responsible manner (optimization potential: due diligence, risk management).
Providers and investors in infrastructure investments
In Germany, the range of funds on offer has been developing positively for years. Investment companies are also increasingly taking advantage of the trend towards securitization. Luxembourg is often regarded as the first port of call for structuring, and the discussion in the field of Public-Private Partnerships (PPP) is also picking up speed. The private equity industry is also in an intensive discussion phase, regardless of the size and cost discussion (the complex area of direct investments is not the main focus at this point). Established industrial addresses, as well as many medium-sized to “small” providers of products, are lining up, as are providers from traditional infrastructure markets: Australia, USA, Canada, Great Britain.
Classic institutional investors such as insurance companies, pension funds, and corporates (Networks) are currently heavily involved in building up know-how internally or make use of external consultants. One can perceive a division of the market in parts: Investors such as certain family offices, foundations, and pension funds are interested in infrastructure investments and also have some internal know-how. With certain sizes and professional networks, certain “club deals” can also come about. Due to the diversity of investment opportunities, some investors tend to take a form of “attention”. In short: Because the effort for due diligence currently seems too expensive, time-consuming, or unmanageable, we wait and see. In particular, if one moves from the investment level of funds to the investment level of direct investment, the degree of complexity in the examination process increases (keyword: investment regulation). Certain investors are currently unable to maintain these auditing capacities or are still looking for solutions. Although this process is not a core trend, the reluctance of some investors may also be caused by the fact that in certain phases the supply of attractive target investments for the funds may become scarce.
Opportunities for portfolio management
Long-term, stable earnings and portfolio diversification are often seen as potential opportunities for institutional investors at portfolio management. Similar to the discussion in the hedge fund sector in the past, the current discussion on infrastructure investments may serve to identify “red flags” in the due diligence of investments as early as possible, correct misconceptions, and successfully manage the promising asset class in their portfolios.
Diversification and risk management
Risk diversification is one of the core tasks of portfolio managers on the provider and investor side (selection) for fund solutions in the infrastructure sector. Similar to traditional asset manager selection, internal and external know-how (consultants) is used to select specific funds. Single and fund of funds solutions are being examined. The fund solutions must fit into the investor’s overall strategy (e.g. insurance). The right balance between “over-diversification” and “under-diversification” must be found, all embedded in the construction of the investor’s overall portfolio. Factors influencing risks can be, for example, cash-flow profile, regulation (AIFM, KAGB, ELTIF, Solvency II, etc.), regions (Europe versus the USA?), economic indicators, operational characteristics of the investment universe, currency and financing model. Forecasts as well as cluster risks in the selection of funds (within and outside the fund level) must also be taken into account. This is a finding that contradicts many common market opinion. If you look at all these points, it becomes obvious that entrepreneurial risks in investments require constant monitoring and reporting and that one cannot per se expect stable long-term returns from every infrastructure investment. This does not contradict the general assumption that infrastructure investments have a positive risk/return profile with stable returns.
Fund management: the importance of due diligence and know-how management
Providers and investors in the field of infrastructure investments are currently engaged in intensive dialogue. Due to the complexity of the offers and the time-intensity of the due diligence process on the investor side, there may be many “frictions” in the hoped-for growth process. Standardization of processes, transparency of decision parameters (regulation, risk management, etc.) is development paths that can be positively influenced by all industry players. Possible questions, without claiming to be exhaustive, are: How can it be ensured that investors – regardless of size, including family offices and insurance companies – all have the same level of expertise when selecting fund products so that they can make timely investment decisions? What assessment criteria should be applied to which type of project (cash flow, valuation rules, etc.)? How do certain target investments influence investment strategy and risk exposure?
It is often forgotten that many investors have to compare the interest in the investment with the effort of the investment check during the due diligence. Additionally, it has to be considered that existing investments require professional monitoring. Neither can all investors keep such expertise in-house nor does it make sense to buy external know-how for every investment decision. As a rule, the selectors have field competence in the financial sector. Special issues from plant construction, operations, or distinguished industrial sectors (energy market, regulation, country risks, counterparty risks, etc.) are often not part of day-to-day business. Countries, sectors, weighting, “green versus brownfield” investment style, launch dates – many questions that are taken into account when constructing a portfolio. The selector is forced to deal with these issues despite the fund cover. A constructive approach to solving such issues: In the family office sector, certain know-how networks are developing in the club deals area, which can provide a remedy when decisions are needed.
Outlook – communication is necessary
Irrespective of the current debate, infrastructure investments should be regarded as classic, long-term investments. If providers, investors, and regulators (including associations) increasingly work towards establishing valuation standards and increasing know-how through investor education, then there is a chance of starting a long, steady growth path for infrastructure investments. Investment practice and long-term thinking would go hand in hand and appear less “fashion-driven” – another positive aspect for the image of the fund industry.