Infrastructure
Refresher reading access
Introduction
Infrastructure investments involve capital-intensive, long-lived assets whose under-lying economic use is associated with the provision of essential services, such as transportation or power generation. While sovereign, regional, and local governments borrow and levy taxes to build and operate infrastructure assets using public funds, our focus in this learning module is the features, structures, process, due diligence, valuation, and portfolio characteristics of private unlisted infrastructure investments. As of October 2022, private unlisted infrastructure remained the fourth largest private asset class after private equity, private debt, and real estate, with over USD1.25 trillion in global assets under management (AUM). This private asset class is forecast by the alternative investment data company Preqin to reach USD1.9 trillion by 2027, approaching the size of private real estate AUM.
Infrastructure investments are characterized by unique, often project-based structures with distinct cash flows and risk and return characteristics resulting from contractual or regulatory arrangements associated with public use. Like other private assets, infrastructure assets are typically large and illiquid—in some cases, involving existing government assets that are privatized, and in other cases, involving new assets built, operated, and often transferred to public use at the end of a predefined operating period.
Learning Outcomes
The candidate should be able to:
- discuss important infrastructure investment features;
- discuss infrastructure investment methods and investment vehicles and their uses;
- discuss the infrastructure investment process over the project lifecycle and the roles of infrastructure debt and equity financing;
- discuss the due diligence and valuation processes for infrastructure investments;
- discuss the risk and return among infrastructure investments and as compared to other investments as part of a strategic asset allocation.
Summary
- Infrastructure investments are single-use, long-lived assets that may be classified on the basis of the inherent business risk faced by investors. The business risk depends on the specific security’s place in the capital structure and its claim on cash flows of the underlying project, as well as the project type, corporate governance features, and geoeconomic exposure.
- Single-asset infrastructure companies typically involve a special purpose company with debt and equity investments closely tied to specific commercial contracts, while investments in entities engaged in multiple projects are more closely aligned with a corporate structure.
- Unlike private equity or real estate investments, which typically seek an exit in several years following capital appreciation due to restructuring or development, infrastructure investments that use a build–operate–transfer structure transfer their assets at the end of an operating period and therefore have a terminal value of zero.
- Due diligence challenges unique to infrastructure investments include jurisdictional, legal, and regulatory considerations; technical aspects of the engineering, procurement, and construction phase; and the commercial terms of their operation as defined by contractual or regulatory relationships.
- Given the unique and illiquid nature of infrastructure assets, valuation approaches generally focus on discounting expected cash flows over the commercial term using risk-adjusted discount rates.
- Because infrastructure assets are characterized by a relatively high payout of cash flows following a construction phase and their returns are less correlated with public bond and equity returns, their inclusion in a strategic asset allocation most often seeks to benefit from both diversification and long-term liability matching.
2 PL Credit
If you are a CFA Institute member don’t forget to record Professional Learning (PL) credit from reading this article.