Illiquid assets

GLOBAL INVESTOR 1.15 — 51
Photos: Imaginechina, Lowell Georgia, Anna Clopet/Corbis
ture management companies such as train operators, pipeline managers,
etc., while they will also purchase bonds where there are credit
guarantees either by government, supranational institutions or banks.
Risks
While the current low interest rate environment encourages increased
allocation into longer-term illiquid assets such as infrastructure, it is
important to focus on the risk factors in the industry and highlight
some examples where investor losses have been generated. For
new projects, the obvious key risk is that projects are either not completed
or have serious delays and / or cost overruns. Recent examples
include escalating costs of building new nuclear plants, projected
overruns in high-speed train lines and toll road tunneling projects.
Political risk has to be carefully assessed; there have been a number
of instances, notably in mining projects in higher-risk emerging markets,
where a change of government has led to contracts / concessions
being cancelled and assets sequestered. Another example of political
risk is the possible change in government subsidies and / or support.
A number of alternative energy projects and notably wind farms have
faced deteriorating economics as government subsidies have been
withdrawn, and likewise social infrastructure projects, which might be
in the form of a public / private partnership, can suffer from reduced
government funding. Environmental issues are critical, notably in the
transport, energy and waste management sectors. Examples of problems
have been the imposition of environmental fines on projects and
infrastructure assets and projected cash flows being delayed because
of disputes over environmental issues. Certainty of cash flows is
obviously important, but in a number of cases, cash flow projections
have been too optimistic. One example has been in toll roads where
they have competed with toll-free roads and traffic has not switched
to the toll roads, with a mediocre outcome for revenues and cash
flows. Another risk is the threat from new technology. For example,
in telecommunications, the future viability of mobile masts has to be
questioned, while initially the excessive installation of fiber-optic
cabling led to major losses. Market price movements can change the
economic viability of infrastructure. At present, the sharp decline in
oil prices is challenging a number of alternative energies, and investment
in oil and gas fracking is becoming less attractive.
Financial risks involve the threat of higher interest rates and / or
wider credit spreads. Increased financing costs will challenge the
economics of infrastructure, make alternative asset classes more
attractive and could delay projects if refinancing needs are not met.
Other market-related risks can be changes in foreign exchange rates
where hedging longer-term assets can be problematic, shifts in
yield curves (which might affect swap pricing where swaps have been
used to hedge borrowing risks) and the use of excessive leverage.
In 2008–09, a number of infrastructure funds had to be restructured
since reduced cash flows could not meet increased borrowing costs
and / or refinancing could not be successfully achieved. The final risk
is that, in “easy” markets backed by quantitative easing, valuations
may become stretched and there is some initial evidence of this occurring
with current transactions in the ports and trains sectors being
effected at values significantly higher than those that took place over
the last five years.
Government policies
In the recent G20 communiques, the G20 stated “we are working
to facilitate long-term financing from institutional investors and to
encourage market sources of finance, including transparent securitization,
particularly for small and medium enterprises and we endorse
the multiyear program to lift quality public and private infrastructure
investment.” It is obvious that at the level of individual governments
and also the IMF, OECD and EU, accelerating infrastructure projects
is a clear macropolicy objective. S & P has estimated that infra structure
financing needs worldwide could total USD 3.4 trillion annually until
2030. For governments, infrastructure investment is clearly attractive
given the initial positive impact on employment and the longer-term
multiplier effect on the economy.
Trends
There are a number of clear trends in the infrastructure sector. First,
new investment from investors such as pension funds that need
long-term assets and do not need liquidity will increase significantly.
Second, investment in infrastructure will have the support of governments
and supranational institutions given the strong economic
multiplier effects. Third, the environment for investing in greenfield
projects / start-ups will remain challenging and will require project and
credit support. Fourth, investors will focus on areas where there is
inflation protection, minimal systemic risk, and where leverage and
financial risk is intelligently managed. Finally, the flow of equity capital
will be matched by the development of the infrastructure bond
market as an alternative to bank financing.
Robert Parker
Senior Advisor
+44 20 7883 9864
robert.parker@credit-suisse.com