Moving up the risk curve
06 March 2019
Greater competition for core infrastructure assets means many investors are considering how to maintain returns by taking on assets with greater commercial, operational or market risk. At PwC, we’ve seen a lot of our infrastructure clients looking at assets higher up the risk curve.
Some are broadening their geographic coverage, venturing out from stable jurisdictions such as Canada, Australia and the UK. Some are looking at taking on development risk, investing directly into earlier-stage projects, or (preferably) into operational platforms that have the skills to develop a portfolio of assets. But to date, the most common move has been to invest in businesses that are stretching the definition of infrastructure – car parks, airport ground support equipment, crematoria, even infrastructure support services.
There’s no common definition of ‘core plus’ infrastructure, but I’m reminded of the phrase that if something walks like a duck and quacks like a duck, then it’s probably a duck. It’s the same with infrastructure: if the financial statements of a business shows you it is stable like infrastructure and cash-generative like infrastructure, then maybe you can finance it like infrastructure. Clearly this is an over-simplification, and every investor will have their own view as to what traditional criteria they are prepared to sacrifice (does it have to be asset-backed, for example). But the temptation of acquiring businesses that have more moving parts – greater operational complexity, greater opportunities for growth – has been hard to resist for many infrastructure funds.
All of which means infrastructure portfolios are getting, incrementally, a bit riskier. That might be fine as the returns should follow, but it does beg the question of whether the qualities that have made infrastructure the highest-performing major asset class over the last 10 years are being diluted in the search for returns.
It also makes me wonder whether infrastructure funds that are pursuing these strategies have the capabilities to assess and manage this extra risk. If I think about how my private equity clients do this, they have had to develop their capabilities across the deal lifecycle to stay ahead of the competition. For example:
- Proactive and proprietary deal sourcing. The best PE deals are often bilaterals, or complex carve-outs where preparation is everything. Waiting for an auction and then running hard is no longer enough.
- Working up the upside. PE investors will put equal weighting on risk and opportunity, and often balance them off against each other. Most will have a fully developed value creation plan before the diligence phase, so that diligence is just confirmatory.
- Active engagement with portfolio businesses. PE investors are highly engaged owners. They will use both carrot and stick to encourage management to improve the business.
- Opportunistic exit strategy. I remember a survey showing that the biggest driver of PE returns was rising markets. Even investors whose underlying strategy is long-term hold should be prepared to seize opportunities to realise value quickly in this more uncertain world.
I think there may be some interesting parallels here for infrastructure funds. Infrastructure investors should be more engaged owners. Even stable, long-term assets may have potential for value creation and shareholders have a key role in helping management to improve operations, review costs, or find new markets. In another blog we explore what active asset management might mean in practice for infrastructure investors.
At the start of 2019, investors have to grapple with a heady mix of technological, megatrend and political disruption. Finding and managing investments through this environment is harder than ever, and investors that are stretching into new areas will need to make sure that their capabilities are keeping pace with their strategies.