Infrastructure: A global asset class
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Pramerica Capital Group actively invests in infrastructure projects, focusing on investment grade debt in energy, transport, social and water sectors.
Ty Bowman discusses a recent solar farm project financed by Pramerica Capital Group in 2014, which is planned to provide 80 megawatts of clean energy to the local utility as an alternative source of power to consumers.
Infrastructure: A Global Asset Class
The world faces a substantial and growing need for infrastructure – and therefore for infrastructure investment and financing. Traditional public infrastructure funding sources are under pressure resulting in an estimated funding gap of $500 billion per year globally.1 Private sector funding sources are needed if we are going to close this gap.
One way to help address this funding need is to make infrastructure more accessible to investors – in other words, to define it as an asset class, with the requisite analytics, transparency, and terms that such characterization implies.
For life insurers, long term investment strategies, such as infrastructure project investing, are vital to our liability-driven portfolio management process. Efforts to define a global insurance capital regime must consider the long-term nature of the life insurance business. Reflecting appropriate economics of life insurance in a global capital framework is crucial to ensure that private funding is available and stable over time. Solvency II and other frameworks must incentivize investment in long-term assets that allow insurers to match their long-term liabilities. Well underwritten infrastructure investments offer attractive risk, return and diversification characteristics, which can contribute to better asset/liability management, and in turn, stronger companies.
Pramerica Financial, Inc. (PFI)’s businesses have been large providers of long-term capital to a range of infrastructure programs for many years. Its private lending business, Pramerica Capital Group, which operates as Pricoa Capital Group in Europe and the U.K., manages an infrastructure portfolio of more than $10.5 billion (as of June 30, 2015). The Pramerica Capital team focuses primarily on investment grade debt and invests in energy infrastructure as well as in the transport, social and water sectors. In 2012, Pramerica Capital Group created a dedicated infrastructure team to source opportunities globally and in multiple currencies. In the public markets, Prudential Fixed Income, known as Pramerica Fixed Income in Europe and the U.K., holds a substantial amount of infrastructure related public debt for PFI’s portfolios. In addition, PFI participates in infrastructure equity through investing in alternative asset classes.
Is infrastructure an asset class?
No single definition of “infrastructure” exists within the investment community, and assets included across various definitions can range from “greenfield” public works projects to public corporate bonds in telecom or energy sectors. In general, infrastructure investments are categorized within a range of traditional industry sectors and disciplines (e.g., energy, power, transportation, telecommunications, ports, social housing) instead of being distinguished by several principal characteristics. First and foremost, investors tend to think of infrastructure as a long duration asset class, and as such it suits investors with long-term investment needs. Other characteristics commonly cited, beyond the ultimate use of the asset/project itself, include: illiquidity, often manifested in long investment/draw periods, or, if debt, a lack of rating; complexity, requiring specialized skills to analyze; and uniqueness, having few closely comparable investments in terms of structure, assumptions, or returns. Taken together, these characteristics – along with the types of investors they tend to attract – might warrant categorization as a standalone “asset class.”
Why infrastructure assets have a place in long-term investors’ portfolios?
Infrastructure investment may provide unique benefits to long term investors’ portfolios. First, infrastructure can provide diversification. The supply of long-term assets (other than sovereign bonds) is relatively constrained and in high demand. Infrastructure debt from new issuers, whether governmental, quasi governmental, or private, represents a new source of investment opportunity which allows investors to better diversify their portfolios. Infrastructure debt, by its very nature, tends not to be highly correlated with other credit investments in an insurer’s or pension fund’s portfolio. Few other asset classes (other than sovereigns) are able to offer a diverse supply of high credit quality, long-duration assets.
Second, infrastructure has the ability to bring stability, in cashflow and credit performance. Historical rating agency default and recovery data indicates that infrastructure debt investing has lower risk than corporate lending.2 While risk can be high during the planning, permitting and construction phases of some projects, operating risks tend to stabilize or improve over time as the project goes into production. Infrastructure projects tend to have stable cash flows and more limited exposure to competitive forces due to regulated revenue models which help to support the credit over time. This is unlike typical corporate credit where risks and uncertainty tend to increase with duration.
Obstacles and challenges to infrastructure investing
From the investor’s perspective, the features that characterize infrastructure – its long-term nature, illiquidity, complexity, uniqueness – tend to make infrastructure challenging to analyze. A variety of efforts could be made to make infrastructure assets more attractive to investors, including standardization of documentation, improved access to information and analytics about investment performance, and creating structures in which investors of varying risk appetites can find suitable investments across the risk spectrum.
Perhaps more importantly, investors often cite the lack of investment opportunities as a reason for not being more invested in infrastructure. Greater assurance of a “pipeline” of opportunities from project sponsors would also attract investors to the asset class. The further development of Public/Private Partnerships globally may prove to be a powerful vehicle for creating that pipeline. The ability to extract value from existing infrastructure assets to be redeployed towards seeding new projects has the potential to be a powerful catalyst for growth. It enables us to recycle the value of existing societal assets into new productive assets.
Finally, regulatory frameworks around the world must acknowledge the long-term investment needs of their regulated entities and the appropriateness of good quality infrastructure investments to meet those needs. We believe that to date, new regulatory frameworks for banks and insurance companies are creating disincentives to long-term investing. For banks, Basel III constraints that aim to ensure short-term resilience to potential liquidity disruptions by penalizing illiquidity and maturity transformation through levying high capital charges on less liquid long-term investments. In Europe, Solvency II applies significantly higher capital charges to longer-term and intermediate investment grade assets such as infrastructure debt. G-SII, Dodd-Frank and other macro prudential regulation to date have favored shorter-duration, more liquid assets in a financial institution’s investment portfolio. Unfortunately, such regulations penalize the very types of assets that could be used to improve diversification and better hedge liability exposures. In order to promote infrastructure investment, capital charges should reflect the lower risk profile of infrastructure relative to corporate credit over the long term.
We believe that infrastructure investment is not only important to society, but also strategically important for long term investors. Pramerica has had a longstanding commitment to infrastructure as a result of this dynamic. Indeed, we welcome the opportunity to help develop infrastructure into a recognized asset class among long term investors. Better access to information for investors, a more assured supply of infrastructure investment opportunities, and greater understanding among regulators of the importance of infrastructure investments in long term investors’ portfolios, will enable infrastructure to flourish as an asset class.
1 Standard & Poors (http://www.standardandpoors.com/spf/ratings/20140120_GlobalInfra.pdf)
2 Moody’s (Moody’s Investor Service: Infrastructure Default and Recovery Rates 1983-2012H1, December 2012)
Scott Sleyster, chief investment officer of Prudential Financial Inc., (NYSE: PRU), a financial services company headquartered in the U.S. The company is not affiliated in any manner with Prudential Plc. of the U.K. This article represents Sleyster’s opinion as of October, 2015.
Prudential Capital Group actively invests in infrastructure projects, focusing on investment grade debt in energy, transport, social and water sectors.
Ty Bowman discusses a recent solar farm project financed by Prudential Capital Group in 2014, which is planned to provide 80 megawatts of clean energy to the local utility as an alternative source of power to consumers.