Infrastructure investors skirting Asia

A record amount of institutional money is being committed to infrastructure investments, but only a small fraction of that bonanza is slated for new “greenfield” projects in fast-growing emerging markets in Asia.

Of the record $93 billion in uncalled capital, or dry powder, in unlisted infrastructure funds at the end of October, $9.5 billion was dedicated to Asia ex-Australia — a roughly 10% share that has held fairly steady in recent years, noted Elliot Bradbrook, London-based manager of infrastructure data with alternatives investment research firm Preqin Ltd. (All figures in this story, unless specified, are in U.S. dollars.)

By contrast, 45% of that pent-up demand is focused on North America, and 33% on Europe, according to Preqin.

For the most part, limited partners in those funds are seeking “stable and predictable returns/yields from their infrastructure portfolios” — giving established, operational “brownfield” infrastructure assets in Europe and North America pride of place over yet-to-be-built “greenfield” opportunities in emerg-ing markets, Mr. Bradbrook said in an e-mailed response to questions.

That global search for yield has left most investors focused on brownfield investments, even if “a growing minority are willing to consider greenfield,” said Duncan Hale, Sydney-based head of infrastructure research investment at Towers Watson & Co.

And pride could come before a fall — in yields.

Pent-up demand among institutional investors for those lower-risk operational assets in Europe, North America and Australia has produced an “obvious mismatch,” with demand far exceeding supply, noted Karen Chester, a Sydney-based partner with Mercer Investments (Australia) Ltd., and Mercer's global head of infrastructure.

Warryn Robertson, a Sydney-based portfolio manager of Lazard Asset Management's $4 billion global listed infrastructure strategy, said his firm pegs the dry powder war chest at $150 billion — a wall of money driving competition for suitable infrastructure assets, which in turn has left managers of unlisted infrastructure funds paying premiums of as much as 20% to 30% over similar listed infrastructure assets.

Lazard's strategy focuses on assets that have monopoly-like characteristics, are less subject to inflation risk and generally have more predictable return patterns, capable of giving superannuation and sovereign wealth fund clients less volatile returns somewhere between what bonds and stocks are offering, he said.

A number of the region's biggest sovereign wealth funds appear to be in a similar frame of mind.

In its annual report for the year ended Dec. 31, 2012, the $575 billion China Investment Corp., Beijing, cited investments it made during the year of £276 million ($444 million) in Thames Water Utilities Ltd. and £450 million in Heathrow Airport Holdings Ltd. as generating “steady returns” and improving the portfolio's risk-return profile.

Meanwhile, the A$91.7 billion (US$86.9 billion) Australia Future Fund, Melbourne, reported a combined 98% of its infrastructure portfolio — A$7.3 billion as of Sept. 30 — was invested in the developed markets of Australia, Europe and North America. The Future Fund's latest annual report listed a number of infrastructure investments for the 12 months through June, including the acquisition of a 30% stake in Perth Airport, citing inflation protection and “high levels of earnings certainty” as among their charms.

While safety and stability remain the apparent watchwords, amid estimates of infrastructure investment needs of as much as $1 trillion a year in Asia over the coming decades, some money managers see scope for expanding the greenfield portion of global infrastructure funds.

In an interview, Benjamin Haan, a senior vice president with Zug, Switzerland-based alternatives firm Partners Group AG and head of its infrastructure team in Asia, argued for diversifying a global infrastructure portfolio with more greenfield investments in emerging markets.

Brownfield investments in developed markets are a good place to get comfortable with the asset class, but moving to add greenfield exposure in emerging markets can produce a more diversified portfolio and prove “a real return driver,” said Mr. Haan, who is based in Sydney.

Greenfield projects, correctly chosen, can significantly enhance a global infrastructure fund's returns, agreed Mark McLean, Morgan Stanley Infrastructure's Melbourne-based head of Asia-Pacific. But if those projects account for more than 20% to 25% of a portfolio, a fund could become riskier than many institutional investors would prefer, he said.

Partners Group believes about 25% of a global infrastructure portfolio should be allocated to Asia and other emerging markets, Mr. Haan said.

The firm has roughly $450 million of its $2.5 billion book of infrastructure assets under management invested in Asia, including a solar power project in Thailand. Relatively short development periods and a willingness of consumers to pay for electricity make renewable energy one of the safest candidates for greenfield investments, he said.

For now, however, industry veterans predict that growing institutional interest in infrastructure will remain focused on the brownfield end of the spectrum, with investors reluctant to take on greenfield exposure unless it's combined with a heavy dose of existing operating assets.

Few investors “will want to take on single-project greenfield risk,” but many will consider taking minority stakes in infrastructure-related firms in India or China with, say, four or five operating assets, another two or three under construction and one or two under development, noted Vijay Pattabhiraman, Singapore-based chief investment officer of J.P. Morgan Asset Management Global Real Assets.

J.P. Morgan sees scope for private investments of roughly $50 billion a year as the equity portion of anticipated annual infrastructure spending of $750 billion in Asia ex-Japan and Australia.

Likewise, an investment in an Indian road concession, with plans to broaden the road to four lanes from two and start collecting tolls, is somewhere between a brownfield and a greenfield investment, noted Anoop Seth, the Singapore-based head of infrastructure for Asia with Sydney-based AMP Capital Investors Ltd.

Mr. Seth conceded investor appetite for greenfield investments remains diminished since the global financial crisis, contributing to the gap between the region's growing infrastructure needs and the role that private capital is prepared to play in funding those investments.

If the weight of greenfield investments in Asia appears poised to loom ever larger within the infrastructure opportunity set, the supply of brownfield assets may yet prove elastic in key developed economies such as Australia and Japan, market veterans said.

Recent high prices paid for brownfield investments, including the more than $5 billion purchase of leases for two Australian ports this year, could convince cash-strapped governments to offer up more facilities in the near term — leaving greenfield investments accounting for anywhere between 10% and 25% of global funds, said Mr. McLean.

But longer term, growing institutional allocations to infrastructure could well lead investors to “take a long, hard look” at taking on more of the risk-reward trade-offs of greenfield investments, he said.

It remains for regulators and fund managers to develop approaches for dealing with the “buildout” risk of greenfield projects, with different reward structures, to make institutional investors more comfortable in backing those projects, Mr. Seth said.

Preqin's Mr. Bradbrook said his team's conversations with investors around the world point to a growing appetite for Asian infrastructure, as those investors seek to diversify their portfolios.

At present, a lack of experienced Asia-based infrastructure fund managers is proving a hurdle, but one that can be expected to diminish as markets there mature and investment teams become more experienced, he said. n