We believe social infrastructure as an asset class hits a number of sweet spots for investors wanting to make a positive social contribution alongside their returns.
COVID-19 has fundamentally changed the way in which we think about infrastructure assets and the conversation around public borrowing in ways which bode well for future opportunities in the sector. We’ve also been forced to reassess many of our preconceptions around the true nature of risk in asset markets, with profound implications for the traditional portfolio mix.
We believe the prospects for investors are alluring: offering the chance to contribute to a public good such as the education of the next generation, the health of the population, and the provision of clean water and green power; through assets that compare very strongly against other asset classes for those seeking income and defensive positioning.
The defining characteristics of a social infrastructure portfolio.
Social infrastructure assets are the buildings, facilities and networks that facilitate the delivery of social services by governments and other service providers. They can range in scope from schools, hospitals and utilities right through to sporting and cultural venues.
One feature that distinguishes social from core infrastructure, such as roads and airports, is the extent to which revenue is generated on the basis of availability, rather than patronage. In the case of social infrastructure, cash flows are typically guaranteed to a large extent by contract, provided the asset is available for use (irrespective of actual usage).
These are long-term contracts – often for 25 to 30 years, and they provide owners of social infrastructure with very stable and durable cashflows from high credit-quality counterparties (usually governments) with minimal exposure to economic cycles.
This was borne out during the course of 2020, when many core infrastructure assets – particularly in the transport space – were significantly affected by lower patronage, while social infrastructure was relatively unscathed.
Resilience through the pandemic
But the pandemic did more than alter the balance between the performance of core and social infrastructure assets. It expanded the possible investment options for investors.
For retirees, for example, stable income from availability assets was highly prized through a period of lower dividends from equities in 2020. While the hunt for yield pushed many investors out of bonds and into other low-risk asset classes, like social infrastructure.
Looking forward, investors will be less likely to hold cash in the face of rising inflation, and since many social infrastructure contracts contain provisions which link returns to CPI, the sector is a sound alternative in our opinion.
Nonetheless, no investment is risk-free, and expected higher returns for social infrastructure above bond yields do represent a risk premium, but skillful managers have plenty of options for mitigation. For example, we expect portfolios which concentrate on brownfields sites with one or two years of steady operation, could negate a lot of the risk associated with new projects.
And while COVID-19 did change the way in which many assets were used and maintained, the burden hasn’t necessarily fallen on owners. In our experience, Australian governments, for instance, have typically been happy to pay for high-touch point cleaning above the contracted standards. In addition, the new landscape brings new opportunities, as demonstrated, for example, by Perth Stadium’s role as a COVID-19 command centre during the worst of the crisis.
A promising outlook
The low-rate environment has prompted some to advocate for governments to take a more central role in infrastructure funding and provision, side-lining the private sector. Nevertheless, we believe it is more likely that the shift will lead to greater public-private partnership style investment opportunities over the coming years.
The rationale for private sector involvement was never, in our opinion, purely predicated on cost. Instead, the benefits of these partnerships were based on the potential for competition in the private sector to foster innovation and efficiency, and introduce additional expertise into the process. Thanks to their steadily-increasing involvement in public projects over the past few decades, we think that private sector partners are becoming better at delivering projects to schedules and budgets that are pleasing to both governments and their investors, and we believe this capability can only improve in coming years.
Furthermore, although the cost of borrowing may not increase dramatically for governments into the near future, they may have a keen eye to their existing debt burdens in the wake of COVID-19 stimulus, and as a result may be less willing to have the full cost of new projects on their balance sheets.
These dynamics make the argument for public private partnerships all the more compelling, and given the pipeline of new projects that will be needed to keep pace with mega-trends, such as the shift to renewables and our aging population, the prospects for social infrastructure from our perspective look very healthy indeed.
Subscribe below to Institutional Edition to receive my latest articlesCharles Savage, Principal
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