Understanding Infrastructure 2014 AMP Capital Investors Limited ABN 59 001 777 591 AFSL 232497
Understanding Infrastructure About infrastructure at AMP Capital Generating outstanding investment outcomes for clients We believe real asset knowledge and a hands-on approach to managing infrastructure assets can generate outstanding investment outcomes for clients. We offer clients access to direct infrastructure, listed infrastructure and infrastructure debt. With a hands-on approach to asset management and board representation, we seek to influence the strategic direction of the business in which we invest. Clients benefit from our unique knowledge of infrastructure We have been investing in infrastructure since the late 1980s, and have made over 100 infrastructure equity and debt investments globally since then. Our proud history of providing essential infrastructure to communities across the globe means our clients benefit from our unique knowledge of infrastructure. The whole is greater than the sum For us, success is expert investment teams coming together to discover the best possible insights and investment opportunities for our clients. We have one of the largest infrastructure investment teams in the world, with investment hubs located in Australia, the United Kingdom and the United States. Our international network of government and business relationships also means we provide access to what we consider to be some of the best investment opportunities globally. For further information Please visit www.ampcapital.com Table of contents What is infrastructure? 3 The characteristics of infrastructure 4 Investing in infrastructure 7 Risks specific to infrastructure investing 8 1 Towers Watson Global Alternatives Survey 2012 2
What is infrastructure? Infrastructure offers investors the opportunity to own the utilities and facilities that provide essential services and help drive economic growth. Over the last few decades governments around the world have faced increasing budgetary constraints. With greater knowledge of the world s capital markets, and realising that policy outcomes can be achieved without owning or operating key infrastructure assets, governments have crystallised some of their massive investments in infrastructure through ongoing privatisation and partnerships with the private sector. Among the characteristics typically displayed by infrastructure assets are strong, and often dominant, market positions in their respective geographic regions, and the ability to generate stable long-term cash flows. Infrastructure accounts for a growing proportion of global investors portfolios, as its features make it increasingly attractive to pension funds, sovereign wealth funds, insurance and institutional investors. Infrastructure is also attractive to retail direct investors looking for defensive characteristics and long-term cash flows. Nowadays, policy development has seen a growing reliance on private sector funds and public markets to fund the core infrastructure that countries need to support and sustain economic growth. Examples of this include the development of alternative energy markets, utilities, roads, railways, airports, port and loading facilities, communications, health and other community infrastructure facilites, just to name a few. Examples of infrastructure 1 2 3 4 5 1 Melbourne Airport Airports 2 Toll roads asset 3 South Australia Schools Social 4 Thames Water Utilities 5 Angel Trains Rail 3
The characteristics of infrastructure Infrastructure the basics Infrastructure assets provide, or facilitate provision of, essential services that support economic growth, generate productivity and underpin the operation of a society. Infrastructure can be divided into three major sectors: > > Utilities: electricity, gas, communications and water > > Transport: airports, roads, seaports and rail > > Social: education facilities, hospitals and other community facilities Key characteristics Infrastructure assets can offer investors a strongly differentiated set of characteristics compared to other asset classes. These characteristics may include: > > the provision of essential services; > > significant barriers to entry and a generally dominant market position > > long duration assets, often with a life of 30+ years > > have high upfront costs, but low ongoing operational costs > > long-term, stable cash flows, generally with low volatility compared to other asset classes > > inflation-linked contracts and pricing that protects investors from the effects of inflation on long-term cash flows. Key benefits for investors Volatile and uncertain markets are highlighting the benefits infrastructure investment can bring to an investor s portfolio. In addition to the potential for smoother and more predictable performance, by including infrastructure in a portfolio, investors can benefit from: > > Attractive risk-adjusted returns, complementing a diversified portfolio > > Reliable long-term indexed cash flows which can provide a good match for long-term inflation linked liabilities > > Low correlation and volatility compared with traditional asset classes > > Stable long-term yields, with the potential for capital growth > > Defensive characteristics emanating from the provision of essential services > > Potential for value enhancement through active management of the assets. How different infrastructure assets perform Infrastructure assets can be categorised as: > > Regulated and availability style assets > > Demand based/gross domestic product (GDP) linked assets Regulated and availability style assets Regulated assets are businesses where a regulator is responsible for determining the costs the business may charge its customers. This is generally done at set intervals, often every five years. Regulated assets tend to be businesses that provide essential services such as water, electricity and gas distribution. Availability style assets are where the owner is paid a fixed return provided the assets are available for use, rather than a return based on how much the asset is actually used. Examples of availability style assets are schools and other education facilities, hospitals, court houses and police stations and other community infrastructure. In many cases, these types of assets have government and semi-government counterparties. Revenue profile of regulated and availability style assets Due to the essential nature of the services they provide, revenues from regulated assets tend to be relatively stable over time, regardless of the economic or business cycle. Similarly, as revenues from availability style assets are not impacted by usage of the asset, they also tend to be very stable and predictable, and are not generally impacted by economic conditions. This means that these types of assets exhibit strong defensive qualities in a portfolio. Returns from regulated assets generally comprise a strong cash yield with some capital growth. Returns from availability assets tend to consist predominantly of cash yield. Economic cycle Downturn Stable return + CPI Slowdown Stable return + CPI Source: AMP Capital Expansion Stable return + CPI Recovery Stable return + CPI Demand based/gdp linked assets GDP linked assets are assets where performance depends on revenues generated through patronage or usage of the asset, for example an airport or a toll road. These types of assets are often called patronage or GDP linked assets as the performance of many of these assets is influenced by movements in GDP. For example, airports generally enjoy stronger performance as the economy is growing, and vice versa. 4
Revenue profile of demand based/gdp linked assets The performance of GDP linked assets is linked to patronage (usage) of the assets. Generally, as the economy prospers these assets enjoy greater volumes and higher revenues, but when the economy falters or retracts volumes can fall, affecting revenue. Economic cycle Downturn Revenue flat to falling Slowdown Revenue bottoms Source: AMP Capital Expansion Revenue grows Recovery Revenue grows As a result of the link to economic performance and patronage, these types of assets tend to generate long-term cash flows with more volatility, but a higher share of capital growth. As a portion of their revenue is generated on the basis of usage or patronage, that portion generally rises and falls as a function of how the economy is performing. Risk and return profiles by infrastructure sector Whilst the infrastructure asset class is generally defensive in nature, there are still differences in the risk and return profile of assets across the infrastructure spectrum. Illustration of indicative risk and return profile by infrastructure sector Social infrastructure Regulated business Demand based infrastructure Social infrastructure Social infrastructure assets, which include hospitals, schools and education infrastructure, tend to generate extremely stable long-term cash flows on the basis that they are provided on an availability basis. Regulated utilities Regulated utilities are businesses which provide essential services such as water supply, sewerage, electricity or other types of energy. These types of utilities tend to be regulated across most jurisdictions because of their essential importance to daily commerce and life. As suggested by the name, regulated utilities are subject to oversight by a regulatory body, which generally sets the pricing these businesses are allowed to charge for the services they provide to their customers. Performance of regulated utilities tends to be relatively resilient, regardless of the ups and downs of the economy, due to the essential nature of the services they provide. Transport Transport infrastructure includes toll roads, and is classed as a patronage asset. This means its performance depends on how much the service is used. Patronage can be impacted positively and negatively by many factors, so the risk associated with transport infrastructure tends to be higher compared to that of regulated utilities and social infrastructure. For this reason, investors expect a higher relative return for investing in transport infrastructure. Ports and airports Ports and airports are predominantly patronage assets. The more that people use them, the better they perform. Ports and airports by their nature are linked to the strength of the economy. For ports, strong trade and a strong economy translates into greater usage and greater revenue. For airports, the same applies, as more people travel when the economy is strong. Of course, when the economy falters and contracts, these assets experience contraction in usage and ultimately revenue. So for ports and airports, investors expect a higher return because of this higher patronage risk, and the greater volatility in earnings this implies. Return Social infrastructure Add greenfield risk or market based revenues premium Requlated utilities Transport with demand risk (e.g. toll road) Ports/airports Reduce for brownfield risk or availability like revenues premium Communications (e.g. telecoms towers) Communications Communications infrastructure, such as telecommunications and towers, mixes availability with patronage in a technology and communications environment where usage patterns can vary. Communications infrastructure is exposed to greater competition than other patronage assets such as ports and airports. Moreover, communications infrastructure dates rapidly compared to other infrastructure because of the pace at which technology develops and changes. For this reason, there are additional risks that investors require greater returns to cover. Risk Source: AMP Capital, for illustrative purposes only. Risk and return expectations by infrastructure sector explained Risk and return in infrastructure can vary across the spectrum. In general, as with other assets, the greater the risk, the higher the return that is expected by an investor to compensate for that risk. 5
Risk and return profile by asset life stage Infrastructure assets also exhibit different risk and return characteristics depending on their life cycle stage. Infrastructure assets can be categorised into a three stage life cycle as shown below, with each stage offering different levels of return and risk. How risk and return changes according to asset life stage Risk and return Value of asset Greenfield assets Development assets Mature assets low yield, high capital low yield, growth high capital growth high yield, GDP high capital yield, growth GDP capital growth Mature assets Mature assets are assets that are in full operational mode and earning revenues. Once an asset becomes fully operational, it has been significantly de-risked. In theory, greenfield and development risks are no longer applicable, and only general operating risks remain. These may include patronage, financing, and regulatory risks. As the asset has been significantly de-risked, returns are lower than are typical in the greenfield and development phases. The long life cycle which is typical of infrastructure assets may mean that it is extended, upgraded or developed at various points in time. For example, the upgrading of a toll road to add an extra lane, or the expansion of an airport by adding another runway or terminal. As an asset moves into a development, upgrade or expansion phase, risks increase, and consequently return requirements may also rise. Risks over asset lifecycle Development Design & Construction Ramp-up Patronage Operating As project risks decrease, the value of the asset increases The yield/capital growth profile of the investment will also change Infrastructure returns guide Infrastructure assets can deliver a range of different return characteristics. The following table provides a guide to the typical ranges by sector. Guide to returns and risks for typical infrastructure assets for illustration Infrastructure Types 3yr Equity IRR Expected Cash Yields Risk Source: AMP Capital, for illustrative purposes only. The three key life stages for infrastructure assets Greenfield assets Greenfield assets are new projects which are approaching or under construction. The potential for returns from greenfield assets is relatively high, however this is accompanied with significantly higher risk. Greenfield projects typically involve a number of risks that do not apply to operational assets, such as permitting, design and development and construction. In addition, there is uncertainty as to future patronage/usage once the asset becomes operational. Greenfield assets are usually not at the revenue generating phase so capital invested does not generate income until the asset is operational. Development assets Development assets tend to be existing assets which are undergoing enhancement or redevelopment. Investors in these assets expect to be rewarded for the additional risks that may apply (e.g. construction risk). The risks are generally lower than greenfield assets, but higher than for mature assets. Therefore, investors would usually accept a lower return than for greenfield assets, but expect higher returns than they would for investing in mature assets. Social 9% - 11% 4% - 12% Medium Regulated 11% - 12% 6% - 10% Low Rail 12% - 13% 8% - 12% Medium Airports/Ports 11% - 13% 5% - 10% Medium Power Generators 12% - 14% 4% - 12% High Toll Roads/Greenfield 13% - 15% 3% - 5% Medium/ High Source: KPMG, ASFA, for illustrative purposes only. Past performance is not a reliable indicator of future performance. Performance correlation Direct or unlisted infrastructure investments have a low correlation to traditional asset classes and can provide valuable diversification in an investment portfolio. This can be seen in the table below which shows that return correlations between infrastructure and other asset classes are low. Correlation of direct infrastructure compared to other asset classes Fixed income -0.03 Direct real estate 0.48 Global listed property 0.19 Global listed infrastructure 0.26 Australian equities 0.29 6 Source: AMP Capital. Chart based on monthly data from October 2007 to 30 June 2013. Direct infrastructure: AMP Capital Infrastructure Equity Fund; Fixed income: BofA Merrill Lynch Government Bond Index; Direct real estate: IPD Unlisted Wholesale Property Fund Index; Global listed property: S&P Global Property Index; Global listed infrastructure: UBS Infrastructure and Utilities Index, Australian equities: S&P/ASX 200 Accumulation Index.
Interestingly, the correlation between returns for unlisted direct infrastructure and listed infrastructure securities is low at just 0.26. That is, global listed and direct infrastructure returns move together just 26% of the time. For this reason, blending both unlisted and listed infrastructure assets within a portfolio can provide further diversification within an infrastructure allocation. This is illustrated in the table below by the Infrastructure Mix 50/50 which represents a blend of 50% of unlisted / direct, and 50% global listed infrastructure. Hedging characteristics inflation Revenues from infrastructure assets are often linked to inflation, either via a regulated return framework or through contractual arrangements. This means infrastructure assets can provide investors with a hedge against the effects of inflation on long-term cash flows. How are infrastructure assets funded? Infrastructure assets, like many businesses, are typically funded with a mixture of equity and debt. Gearing in infrastructure assets can be relatively high though, this is because of the relatively secure, stable, long-term nature of cash flows generated by assets of this nature. The equity component ranks below debt in a typical capital structure and earns dividends based on performance of the asset, and after payment of debt and other operating costs. Equity can be held directly by sovereign wealth funds, pension and superannuation funds, companies, trusts, individuals and charities. Equity can also be held indirectly through trusts and companies, either unlisted or listed. The debt component of the capital structure can include both senior and mezzanine or subordinated debt funding. Because infrastructure assets are often very large, debt funding may be syndicated which means it is provided by a group of banks lending together. Investing in infrastructure Ways to invest in infrastructure There are a number of ways investors can access the benefits of infrastructure investment. Until recently infrastructure investment was only available to large institutional investors due to the significant amount of capital involved. Today, investors can invest in infrastructure through a number of managed fund and direct investment options. Unlisted infrastructure funds Investors can access infrastructure through unlisted managed funds. These funds can enable investors to access a portfolio of infrastructure assets diversified across asset types, geography, sector, and underlying risk factors. Listed infrastructure funds Many infrastructure assets and companies are now listed on global stock exchanges. Investors seeking exposure to infrastructure returns on a global basis can access world markets through funds that invest in global listed infrastructure securities. These funds provide geographical and sector diversification with the liquidity of listed securities. Volatility in world equity markets can provide active managers of listed infrastructure funds with additional trading opportunities over and above asset selection. Conversely, this means as returns are affected by equity market performance, they can be expected to be more volatile than those from direct or unlisted infrastructure assets. Blended infrastructure funds Investors can also access infrastructure through funds that blend listed and unlisted infrastructure assets, effectively combining the benefits of both assets within the one fund. Blended infrastructure funds seek to mix the benefits of the two different types of ownership, unlisted and listed. Open and closed ended funds When investing in infrastructure through pooled vehicles, there are two main approaches, open and closed ended funds. Open ended funds. These do not have a fixed term. In this regard they are well suited to long duration infrastructure assets which often have lives of 30-50 years or more. Open ended funds typically allow investors to increase their holdings from time to time and similarly provide a level of liquidity, usually on a best endeavours basis. Closed ended funds. These are company or fund structures that have a defined life often around 10 years. They raise capital at the start of the fund s life, then have a defined period to invest that capital. They then seek to realise investments and return proceeds to investors at the end of the fund s life. Typically, once invested, an investor cannot access their investment until the fund s term has concluded. Infrastructure debt In addition to investing in infrastructure equity, investors can invest in the debt side of high quality infrastructure assets through infrastructure debt funds. Infrastructure debt provides investment yields that rank ahead of equity in a company s capital structure. Customised accounts Large sophisticated investors with significant amounts to invest may elect to access infrastructure through a customised or separately managed account. Customised accounts are tailored to meet the specific risk and investment preferences of the investor, including risk and return (including yield) requirements, sector and geographic preferences, particular themes or governance requirements. 7
Risks specific to infrastructure investing In infrastructure, investment risks vary depending on factors such as an asset s stage of development, industry sector, location and individual characteristics. Risks such as changes in interest rates and political events can also affect an infrastructure asset s return profile. The following risks are among those that infrastructure investment managers consider when sourcing and investing in infrastructure assets. Counterparty risk Owners of infrastructure assets rely on the regularity of earnings, and the quality of the entities or counterparties that back the payment of these earnings. In many cases, particularly in the case of social infrastructure, the counterparties are, or are backed by, government and semi-government entities. In other cases, infrastructure assets rely on payments from their users who may range from individual users (e.g. drivers using toll roads) to trans-national or national corporations. In the case of corporate counterparties, the quality of the income generated from the assets they use will generally share the same credit rating as the paying entity. Infrastructure assets like airports, energy transmission infrastructure and ports rely on the corporate users of these assets such as airlines, shipping companies, and energy companies. Patronage risk Patronage risk is the risk that usage of an asset will not be at the levels that were anticipated, or that are required to generate a satisfactory return in investment for a given level of risk. This could be fewer motorists using a toll road than forecast, less people flying from an airport or a decreased number of containers passing through a seaport. Interest rate sensitivity and refinancing risk Due to their high values, and long-term and predictable cash flows, infrastructure assets tend to be financed with relatively high levels of debt. Asset performance can be impacted significantly by changes in interest rates, although typically infrastructure assets that have large interest rate exposures will hedge those exposures. In addition, if the tenor of the debt is shorter than the asset life (which will often be the case), then the debt will be required to be refinanced during the life of the asset. Changes in availability and pricing of funding may also impact asset performance. Regulatory risk As their services are essential to society, some infrastructure sectors are regulated by government to ensure these services are provided efficiently and at an affordable price. This can take the form of price control or the setting of expected service levels, or both. The extent and nature of regulation, including any changes to the regulatory approach, can have a direct impact on both investment risk and returns. Contact us If you would like to know more about how AMP Capital can help you, please visit ampcapital.com Important notice to all investors: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided. AMPC_UnderstandingInfrastructure_060114_Retail