Investing in Infrastructure
Diversification among basic and more opportunistic infrastructure investments is critical to mitigate the specific risks of individual projects. Read the post to learn more on investing in infrastructure.
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Investing in Infrastructure
The world will require $57 trillion worth of new infrastructure over the next 15 years, according to the McKinsey Global Institute.* With a growing appreciation for the pressing needs to repair and build new infrastructure, investors are increasingly looking to add investing in infrastructure to their portfolios. But, not all infrastructure is created equally.
Infrastructure offers investors several key investment benefits, including:
- Predictability—Most infrastructure assets hold a monopoly position and serve a community’s essential needs. Accordingly, cash flows tend to be stable and inelastic to economic cycles.
- Potential for Long-Term Returns—Lack of competition generally allows for fair returns to be earned through time.
- Inflation Hedge—While pricing is frequently determined in concert with regulators, most providers are able to raise prices to reflect inflation and economic growth.
- Portfolio Diversifier—Infrastructure investments have low correlations to traditional asset classes, which can help portfolios become more efficient and protect investors against sharp market downdrafts.
However, investment in infrastructure is not without its risks, including:
- Political and Regulatory—The political climate and regulatory environment may differ greatly among local, regional and national jurisdictions. It can also change quickly, adversely affecting an owner’s costs and income stream.
- Liquidity—The size of many infrastructure projects, the limited universe of possible investors and regulatory restrictions can make disposition of such assets very difficult, especially in a down economic cycle.
- Difficult to Model—Since infrastructure as an asset class has limited historical data attached to it, it is difficult to assess the most effective and appropriate allocation level.
- Optimistic Projections—The investment value of any individual project is based on development cost, maintenance expenses and revenue projections which, if estimated incorrectly, can undermine its long-term returns to investors.
- Credit Market—Some operating companies may seek to use leverage in view of its consistent cash flow. However, changing credit market conditions can negatively impact such leverage use.
- Currency Volatility—Where overseas infrastructure investments are made, the return on investments may be impacted by changes in currency value.
There are a number of sub-sectors to the infrastructure asset class. Each will be driven by a different set of revenue streams, risk factors and responses to economic conditions. For instance, the cash generation and economic cycle immunity of a toll road or water system will be considerably different than a correctional facility or a development project in an emerging market country.
Diversification among basic and more opportunistic infrastructure investments is critical to mitigate the specific risks of individual projects.
See referenced disclosure (2) (4) at http://blog.americanportfolios.com/disclosures/