EMILE DU TOIT: Why perpetual capital vehicles are key to infrastructure investment in Africa
This asset class has the ability to uplift entire countries and can provide pension funds with stable, long-term returns
Infrastructure investment has become front-page news thanks to US President Joe Biden’s proposed bipartisan $1-trillion infrastructure bill. Investments in infrastructure have enormous benefits for societies, and this asset class has the ability to uplift entire countries.
Infrastructure investments provide pension funds with stable, long-term, predictable returns and cash flows. Their risk profile is relatively low and returns are mostly uncorrelated to listed equity returns. Crucially, as returns are not very volatile year to year, there are no sudden liability gaps in a funded profile.
The McKinsey Global Institute estimates that infrastructure has a socioeconomic rate of return of 20%. In other words, one dollar of infrastructure investment can raise GDP by 20 US cents in the long run. The world spends more than $2.5-trillion a year on infrastructure, but $3.7-trillion a year will be needed through 2035 just to keep pace with projected global GDP growth. The challenge we face now is scaling up investment to keep pace with these demands.
One of the tools we see as critical to meeting this challenge is perpetual capital vehicles (PCVs), which are gaining traction in more developed markets as an alternative to traditional private equity (PE) vehicles, and we believe they can come into play to open up infrastructure investing in Africa on a larger scale to pension funds.
PCVs — also known as “open-ended funds” — include all listed and unlisted investment holding companies. Infrastructure Investor magazine lists 66 open-ended infrastructure private equity funds on its website, including IFM Global Infra Fund ($34bn), Blackstone Infra Partners ($14bn) and PGGM Infra Fund ($7bn).
There are some common criteria between these PCVs that underline their suitability for infrastructure investing. They are structured as investment holding companies with diverse subsidiaries but within a common vision and corporate strategy. Their management centrally controls asset allocation decisions and leverages the balance sheet to make new investments.
Critically, a PCV caters for a wide range of investors such as pension funds, development finance institutions, banks, asset managers and high-net-worth individuals and their investment horizons and liquidity requirements. They deliver a combination of growth and yield, and overall returns well above inflation. known as net real growth. Management teams are incentivised to deliver consistent net real growth.
The three key areas where PCVs enable pension funds to increase their exposure in infrastructure investments are in terms of liquidity, strategic platform building, and scale and exit benefits.
• Liquidity. When directly investing in an infrastructure asset, the distributions, while predictable, are back-ended as the debt reduces in a project. When investing via a PE fund, distributions occur mostly when the PE fund exits or sells the asset, resulting in lumpy, unpredictable and also back-ended payments. Also, in a PE fund, unexpected drawdowns can create near-term liquidity risks.
However, when a pension fund invests in an infrastructure PCV, the liquidity risk is mitigated. This is for several reasons. As the PCV owns a portfolio of assets at different maturity levels, it can make cash distributions (dividends) with no ongoing drawdown risk and no need to exit a project to create liquidity for investors. Investors can also trade and/or sell the shares in the PCV, whether listed or on the secondary market. Investors can therefore gradually increase or decrease exposure, without having to force an exit of an underlying asset.
• Strategic platform building. Investing directly in a single infrastructure asset or through a limited life PE fund does not provide the ability to build long-term, strategic, sector-specific platforms and capitalise on the demand in this asset class. Investing in an infrastructure PCV allows management to aggregate assets within a specific subsector, across different countries to create an African-wide leader in its sector. This in turn improves the ability to negotiate contracts with customers and suppliers and improves the success rate in tendering for competitive bids in terms of track record, balance sheet strength and experienced management. The diversification benefits within the platform companies mean temporary problems at one or two projects do not pull the entire company down. This contributes to overall risk mitigation for the investor.
• Scale and exit benefits. There has always been a challenge in exiting a minority shareholding in a single stand-alone African infrastructure project. The universe of buyers is basically restricted to other African infrastructure PE Funds. The reason for this is simple: the lack of scale and diversification benefits does not incentivise large players to even start a due diligence process.
This is again where PCVs really shine. Building large-platform companies with a specific focus on key sectors such as renewables, telecoms and airports offers a much more attractive target with significant scale, diversification, expertise and continental reach. These platform companies can be listed separately to achieve a partial exit and higher valuation. This in turn attracts global infrastructure funds in the $5bn to $20bn range, attracts multinational industry players and introduces various options for mergers & acquisitions.
Large sector-based PCV platforms can be actively managed and deliver a combination of cash dividend yield and the ability to reinvest in new growth prospects. Another advantage is active balance sheet management to reduce the cost of capital, which can result in more competitive bidding for projects without impacting equity return. At the holding company level, PCVs offer specific benefits such as the ability to invest in new leading technologies via platform companies.
It has been demonstrated globally that building connectivity infrastructure such as roads, railways and telecoms drives higher GDP growth. However, to fully realise this opportunity, more innovative funding and liquidity options and investment vehicles have to be developed to suit the requirements of pension funds.
• Du Toit is Harith GM of fundraising & liabilities management.
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