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Infrastructure investing: down the river with a paddle

Dam overflowing
| Investment Landscape

Infrastructure investing: down the river with a paddle

The Fish River floats one of the largest annual canoe marathons in the world, attracting thousands of paddlers and spectators to its rapids and banks. Like nearly every sporting event in 2020, it was abandoned.

If not for a brilliant piece of engineering, the race would be cancelled far more frequently.

Beneath the Suurberg mountain plateau in the Eastern Cape lies the longest continuous aqueduct in the southern hemisphere. Known as the Orange-Fish Tunnel Project, it draws water from the Gariep dam (filled by the mighty Orange), channeling it underground through 80km of subterranean concrete before exiting into the Fish River. It remains open for 11 months a year.

Canoeists are not the only ones who benefit from the subsequent higher water levels. The more reliable current sprung a multi-million-rand citrus industry with the accompanying job creation; supported the growth of local industrial businesses; and improved water security for thousands of households.

Infrastructure creates key deliverable of sustainable investing

Infrastructure projects create positive knock-on effects, both economic and social, in the communities in which they are developed. With proper planning, execution, management, and transparency, they can help to uplift current generations while providing a better starting point for those that follow, the key deliverable of sustainable investing.

In South Africa, our need for such investment is glaringly obvious and need not be debated.

What must be explored more rigorously is how these projects come into being and what benefits await investors who stump up the required capital.

Collaboration across public and private sectors

In general, governments must provide their citizens with two types of infrastructure:

  1. that which addresses social needs, like hospitals and housing; and
  2. that which promotes economic opportunity, like roads and railways.

In most cases, these projects demand significant resources and so require stakeholder collaboration across both the public and private sectors. A symbiotic relationship between government and business is critical in developing a pipeline of ‘bankable’ infrastructure projects where the risk/return profile makes financing them possible.

Willing investors can then choose to lend to the entity developing the project (debt) or they can buy a stake in the asset (equity).

Certainty and longevity of cashflows ideal for liability matching

Arguably the biggest attraction of infrastructure as an asset class is the certainty and longevity of the cashflows that the underlying assets produce. To understand why those benefits exist, consider the N3 toll road, one of the most successful South African infrastructure projects made possible through a public private partnership (PPP).

The certainty of cashflows arises from the contractual agreement in place between SANRAL (public) and the N3 Toll Commission (private). The latter is responsible for the design, construction, finance, operation and maintenance of the road in exchange for a share of the fees collected at the tolls. And because the road provides an essential service, the risk of those fees drying up is very small.

The longevity of cashflows is thanks to the lifespan of the asset. Roads typically last 18-25 years so it makes sense that any contract to develop and manage them would be of a similar length. In this case, the N3TC was awarded a 30-year contract.

These two characteristics make infrastructure an attractive proposition for any investor who needs a predictable stream of returns to match their long-term liabilities – a pension fund or insurer, for example. What’s more, the cost of using such infrastructure is most often tied to inflation, which means the returns that accrue to investors should provide real growth.

Exclusive diversification

The size and complexity of infrastructure projects have, up until recently, precluded most investors from gaining exposure to the asset class. But given their importance in the context of creating a sustainable future, conduits are opening up to mobilise the amount of capital needed to achieve the likes of the UN’s 17 Sustainable Development Goals (SDGs).

Still, investors who want access to the asset class must rely on a finite number of skilled dealmakers to identify and package the right infrastructure projects. That means there’s an element of exclusivity that comes with investing in infrastructure. And, generally speaking, less crowded asset classes tend to hold the greatest potential returns.

While guaranteeing performance is foolhardy, the diversification benefits from the asset class are dependable. In addition to the stable stream of long-term cashflows that transcend economic cycles, the lengthy lead times involved with developing infrastructure projects means that opportunities to deploy capital are often available even when traditional asset classes look unattractive.

Sanlam supports the draft amendments to Regulation 28

Sanlam recognises that infrastructure investing has a very direct and positive social and economic impact. The recent draft amendments to Regulation 28 are intended to aid our country’s economic recovery and increase productive capacity. We welcome the opportunity to make formal comment on the amendments and will play a key contributing role as we invest in infrastructure in strategic areas of the economy.

Sanlam Investments has an experienced team of infrastructure finance professionals who are well versed in originating, executing and managing infrastructure assets. Sanlam’s infrastructure portfolio is currently valued in excess of R8 billion, comprising 19 assets with a highly visible pipeline of transactions at different credit assessment stages.

Let’s create regenerative, circular economies

There has been a marked shift in the type of infrastructure projects that are being brought to market. Modern day asset managers that take seriously the tenets of ESG investing must channel capital into the projects that help create regenerative, circular economies characterised by the likes of renewable energy, green buildings, and zero emission industries.

To be sure, the same applies to investing across other asset classes. As custodians of capital, asset managers and trustees have the power and responsibility to allocate resources with a dual mandate: generate excellent risk-adjusted returns for the end investor while keeping the bigger picture in mind.

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One Response to “Infrastructure investing: down the river with a paddle”

May 28, 2021 at 8:23 am, Jennifer Lee said:

Awesome article!

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