NATHANIEL MICKLEM: Infrastructure chance awaits as developmental and commercial credit converge

There was a time when one could draw a clear distinction between two categories of credit investors — those seeking to make an impact, such as development finance institutions, and those seeking to achieve good returns, such as banks or fund managers.

Now, as sustainability and environmental, social & governance (ESG) considerations become increasingly important for asset owners, banks and fund managers, developmental and commercial credit are converging, particularly in infrastructure.

As the focus on climate and the road to net zero carbon emissions intensifies, so too does the imperative for pension funds to extend their focus beyond the narrow parameters of risk and return to a broader remit incorporating risk, return and impact.

The return on developmental lending is higher than expected, mainly due to a lower loss experience due to supporting critical infrastructure and services. It is no longer the case that to contribute to development and invest sustainably investors must accept much lower returns.

Development finance institutions were at the forefront of this convergence as they sought to “crowd in” commercial investors, structuring investments with a more commercial mindset. Blended finance — the use of development finance for the mobilisation of additional finance towards sustainable development in developing countries — has blossomed, initially with different tranches of debt into the same projects, where developmental lenders take more risk.

However, increasingly commercial and developmental lenders are side by side as commercial investors see the opportunity to invest sustainably, while still achieving good risk-adjusted returns.

Bottom quartile

The convergence of commercial and developmental investment has come at the right time given the enormous backlog of infrastructure spending. The primary constraint, and thus need, is debt funding. Most infrastructure projects are owned by the government, state-owned enterprises or large corporates, so there are limited opportunities for equity investing. But almost every project needs debt. In addition, even where equity is available, credit makes up about 80% of funding in most projects.

According to the National Development Plan, SA should be spending at least 30% of GDP by 2030 on infrastructure to promote inclusive economic growth. Yet spend has tracked well below this target since the early 1980s, and also significantly lags other faster-growing economies. Compared with the rest of the world, we are in the bottom quartile of gross fixed capital formation (GFCF) as a percentage of GDP, with the World Bank estimating it at 13.7% in 2020. In stark contrast, China’s GFCF as a percentage of GDP was more than 42%.

The lack of investment in critical infrastructure has been one of the contributing factors to poor economic growth. Recent steps by the government and industry bodies are laying the foundation to correct this imbalance, and commercial credit investors are starting to wake up to the opportunity.

The growing recognition that debt can be sensibly deployed into physical assets at scale while meaningfully contributing to SA’s future growth does not imply a sacrifice in returns. 

SA has historically faced significant infrastructure investment challenges, from low levels of government support to lack of investor capability and capacity, and a lack of pipeline. Now, the landscape is improving rapidly. Not only has the government instituted numerous policy reforms, but it has coincided with a wealth of private and public sector investment expertise able to cater to a deep savings pool.

The government’s infrastructure investment plan presents ample opportunity for private investment, representing an investment value of more than R2.3-trillion in more than 200 projects, spanning all sectors from transport, water and energy to human settlements and ICT/digital communications. 

SA has a critical need to invest in infrastructure, as a primary boost to activity and as a facilitator for growth. There is an enormous funding need, which will require commercial and developmental lenders. On the commercial side, banks will not be enough and fund managers and asset owners are critically important to achieve the required investment.

To succeed, a collective effort between the government, asset owners, asset consultants and the investment management industry is needed.

• Micklem is a portfolio manager at Ninety One.