Study reveals why infrastructure should form part of the modern investment portfolio

Oct 11, 2017

Direct investment in energy infrastructure have proved very successful in developed markets for decades. However, wind and solar energy projects have not been readily available to South African investors. This is now changing and investing in these assets could offer similar returns to property, at lower risk.

The results of a new study, titled Renewable Energy Infrastructure Risk & Return in South Africa, suggests that infrastructure – particularly renewable-electricity assets – deserves a place in the modern investment portfolio, along with conventional asset classes such as equities, bonds, cash, and real estate.

The research, the first of its kind locally, modelled the performance of South African renewable energy infrastructure assets over a 13-year period utilizing historical data, and found that on average, the wind and solar projects’ annual return of 12.98% and 13.16% respectively would have been higher than that of the property index’s 12.85% and slightly below the JSE all share equities’ index of 13.76%, but at considerably less risk than these two ‘traditional’ asset classes.

“In the aftermath of the 2008/09 financial crisis, institutional investors and pension funds have been seeking to spread their investments across a much wider spectrum of assets in the pursuit of new sources of return and means of diversifying risks. Infrastructure has been a beneficiary of this shift in thinking,” says Mich Nieuwoudt, Chief Investment Officer of GAIA Infrastructure Partners and one of the authors of the study.
However, private investment in infrastructure is not new, and in regions such as Western Europe, the private sector contributes to as much as 60% of the funding for new build infrastructure projects. Infrastructure assets as a pension fund investment alternative was first popularised in the United Kingdom following the extensive privatisation of public assets during the Margaret Thatcher administration in the late 1970s and 80s. Other countries soon followed suit.

Infrastructure assets – which include power, transport, and water schemes, among others – as a defining characteristic operate in an atmosphere of limited competition due to natural monopolies, government regulation or concessions and are therefore less exposed to economic and valuation cycles, unlike property. Due to the criteria of operating in an environment of little or no competition, infrastructure assets have the potential to provide investors with predictable returns and long-term, low-risk inflation protection.

However, this is not necessarily the case for all projects, and it is the duty of the infrastructure fund manager to ensure that these characteristics are indeed present and lasting in the assets it invests in, and that the contractual framework which governs the asset’s operating environment supports these financial characteristics.

Access to infrastructure as an investment alternative is now also available in South Africa because of the government's Renewable Energy Independent Power Producer Procurement Programme (REIPPPP), which has made it attractive and transparent for independent companies to produce electricity for sale to the national utility Eskom. The REIPPPP has been lauded as an international success and has so far not been subject to any accusations of corruption.

The generating capacity and tariff for each REIPPPP project is set for 20 years, adjusting annually with inflation, and is regulated by a power purchase agreement (PPA) between the producer and Eskom. The PPAs are underwritten by the South African treasury in the form of an explicit payment guarantee, which ultimately assigns to the projects the same counterparty risk as a government bond.
There are currently a range of options available for investing in infrastructure, including: investing in listed and unlisted infrastructure funds, directly investing or co-investing in the infrastructure project company, or providing debt or hybrid debt-equity instruments.

Risks common to infrastructure as an asset class are mainly political and regulatory, while asset-specific risks can include project-cost overruns, construction delays, the project not performing to expectations, unscheduled downtime, and interest rate volatility. Infrastructure investments are, however, considered generally low-risk, especially projects that are already operational, as the original operating assumptions are substantiated through verified data.

Nieuwoudt adds: “Our research illustrates that inflation-linked renewable energy investments provide consistent, inflation-beating returns with favorable risk-return and diversification characteristics in comparison to traditional asset classes. The growth of this exciting asset class is therefore justified.”

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