Jun 2017 by Caroline Rasmussen
June 5th kicked off what the White House dubbed "Infrastructure Week", during which President Trump delivered several speeches at the Department of Transportation and elsewhere touting his trillion dollar infrastructure plan.
June 5th kicked off what the White House dubbed "Infrastructure Week", during which President Trump delivered several speeches at the Department of Transportation and elsewhere touting his trillion dollar infrastructure plan. The current, growing, and ever more pressing need to repair and upgrade the nation’s infrastructure is one of the few points on which both parties broadly agree. This relatively strong bipartisan support combined with an administration that appears to be prioritizing the issue has generated much excitement and anticipation about infrastructure investing both in public markets and the private investment community.
Optimism around infrastructure is well founded even without current political tailwinds, as the nation’s ability to continue delaying infrastructure investment is rapidly diminishing. Take water, for example. The American Society of Civil Engineers 2017 "report card" on America’s infrastructure gave the nation’s drinking and wastewater facilities a frightening D and D+, respectively, on the basis of capacity, condition, funding, future need, operation and public safety.1 To improve, America will need to spend $685 billion on its water infrastructure alone over the next 20 years, according to EPA data produced under President Obama.2
A record $63 billion flowed into unlisted infrastructure funds last year3, consistent with the stated intentions of a wide cross section of institutional investors to increase their infrastructure exposure, per Coller Capital and OMFIF surveys released in June.4 For example, recognizing long term growth prospects from the unavoidable need for water infrastructure upgrades, private equity firm Clayton, Dubilier & Rice (CD&R) recently paid $2.5 billion for Waterworks, HD Supply’s pipes, sewer, storm and fire unit.5 But these investors aren't just increasing their infrastructure allocations on the hope that the Trump administration will be able to implement an infrastructure stimulus plan. Many face an asset-liability mismatch that it makes eminent sense to fill by owning long-lived assets with low risk, inflation-protected, and stable mid-to-high single-digit cash yields, such as infrastructure.6
More broadly, infrastructure’s steady, predictable return profile is attractive to any investor facing low returns from fixed income, a possible peak in equities and an overall uncertain economic prognosis late in the market cycle. Importantly, infrastructure returns typically have low correlation to other major asset classes as a result of their inflation-protection characteristics and low usage volatility, providing diversification benefits that only become more compelling in a market correction scenario.7 Demand for electricity, water, transportation, and telecommunications is relatively inelastic for obvious reasons, which provides investors with a measure of economic downside protection that is difficult to find in other asset classes. Further, revenues associated with assets such as toll roads and power plants are often either effectively guaranteed by the essential nature of the services, or contractually guaranteed via output purchase agreements.
If President Trump can push through his agenda, infrastructure as a secular investment opportunity will only become more attractive. This is because his proposal in its current form effectively amounts to large-scale privatization, which would give investors greater control of projects. However, due to the plan's lack of implementation detail, objections to the $800 billion tax break component, and the fraught environment in Washington, full execution may be challenging. As a result, investors should build any future federal stimulus into their upside modeling, rather than the base case. Regardless, given the large and diverse addressable infrastructure opportunity, the maturity of the market cycle, and continuing low risk-adjusted yields in traditional fixed income, illiquid assets such as infrastructure investments that can deliver stable, inflation-hedged cashflow as well as diversification and downside protection are likely to become increasingly interesting.
(2) Private equity bets water will wash its face, Antony Currie, Reuters, June 7, 2017
(3) BlackRock’s Barry Says Infrastructure Deals Offer No Quick Fix, Sabrina Willmer, Bloomberg, June 6, 2017
(4) Public sector investors favour real estate, renewables, Reuters, June 12, 2017; LP appetite for private equity cools, PEI, June 12, 2017
(5) Private equity bets water will wash its face, Antony Currie, Reuters, June 7, 2017
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