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Build Your Portfolio by Investing in Infrastructure

As the economic slowdown peters out and recovery shoots arise, governments are still making good on their promises of infrastructure spending in their massive stimulus packages. And it may be just the time for investors to make money off these government-initiated projects.

Infrastructure investments can focus around traditional means like roads and rail, as well as on social building blocks such as hospitals and schools which are becoming increasingly open to investors through infrastructure funds.

Toll roads, ports and airports are at the higher risk end of infrastructure investment, according to Chris Elliott, CEO of Barclays Infrastructure Funds. At the lower risk end there's social infrastructure, which is the financing of government-sponsored projects like hospitals, schools, roads and courthouses, an area where Barclays Infrastructure Funds predominately act, Elliott added.

"Social infrastructure gets a very different risk and return profile from economic infrastructure for the investor," he said.

Governments around the world have gradually adopted models like a Private Finance Initiative to engage the private sector in building infrastructure. It is a model that sees investors contributing to a fund that has won the government contract to finance infrastructure. If enough money is raised for the construction and the project is completed successfully, the government pays a contractual fee which is then returned to the investor.

The Returns

Construction Highway
AP
Construction Highway

"On traditional PFI, PPP (public-private partnership) projects, they tend to be fairly contractually fixed, so the rates of return are between 10 and 20 (percent), depending on the projects. There's a relatively limited upside from those projects," Paul Davies, partner at PricewaterhouseCoopers, told CNBC.

If you're looking at listed vehicles, like Barclays' infrastructure fund, you're looking at returns of between 5-7 percent a year, according to David Stevenson, columnist at the Financial Times. "Pretty steady year in, year out," he said.

The targeted returns for infrastructure funds vary, but most of them offer a 18-22 percent return on investment, which in itself is attractive, Mark O'Hare, managing director of Preqin, said.

"It may not be as high as a typical buyout fund or venture fund, but the risk is a lot lower and it's, in particular, usually index-linked and that's a great attraction to an investor whose liabilities are index-linked," O'Hare added.

"In social infrastructure there are two phases to the project. One is the construction phase and the other is the operating phase. They are called primary and secondary," Elliott told CNBC.

"In the primary phase there is no income at all but there's appreciation when the asset is built. In the operating phase there is a consistent yield. Because we (Barclays) are paid on availability payment, as soon as the facility is made available we receive our full income. We receive that from the contract we have with the government, so the investor will get immediate yield in the secondary market."

A large amount of government stimulus is paid for infrastructure projects, intended to rebuild economies.

"The long-term impact will be huge. We haven't yet had an impact, primarily because infrastructure projects are very long-term projects. They take a long time to plan and a long time to invest and so on. However, the stimulus package will have a big impact," O'Hare said.

"Over half the states in the U.S. have had approval for private finance to take part in public assets — that will have a big impact; that will create a lot of opportunities for investors, both private investors and public pension plans in these things," he added.

The Risk

There are around three or four listed infrastructure funds on the market that investors can buy into, Stevenson said. He suggests investors do their research, look at the underlying assets, and understand what they are actually buying.

"A bunch of assets like hospitals for instance, is radically different than a bunch of American toll roads," Stevenson said. "American toll roads have been not a great investment. Hospitals and PFI have been very good investments to date, as long as the financial models underpinning them hold steady."

There is a skill involved, according to Davies. Developers must deliver the project within timing and costs and make it work properly.

"What happens up front is there's a vast number of due diligence done for the investor and the banks to make sure the contract is in place; the pricing is correct… Because that happens, the actual incidents of problems compared to traditional procurement, where things used to be over time, over budget, has really reduced," Davies told CNBC.

Infrastructure funds took a big knock in the downturn. In the year to date, they have raised 30 percent of what they achieved last year. But forecasts are positive.

"If you look at the number of private infrastructure funds that are on the road at the moment, which means out there raising money, there are, by our reckoning, 83 of them aiming to raise $96 billion. So that is a vast amount of money that people are targeting to invest in infrastructure assets," O'Hare said.

Another way to gain exposure is you can buy stocks in the construction sector.

Or if you are willing to take a riskier route, invest in new infrastructure in the emerging markets.

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Alternative Investing 2012