Social infrastructure plays a critical role in economic activity, productivity and social welfare. It can be defined as the things that are necessary for a society to function.
It includes everything from schools, hospitals and prisons to transport networks such as roads and trains. Historically, local and national governments were responsible for creating and maintaining such buildings and services.
Changing demographics have made infrastructure even more of a priority for governments across the world. With public funds limited, social infrastructure companies provide the capital to help to fund investment. They can deliver better public services through operational efficiencies. They also transfer the risks of ownership to the private sector.
What drives returns and what are the risks?
Public-private partnerships (PPPs) access private capital to develop vital social infrastructure. Introduced in the UK in the early 1990s, the use of these partnerships increased in 1997. Following the election of a new Labour government, they became the preferred funding method for large infrastructure projects. Over the past 20 years, over 700 projects have employed around £60 billion of private capital.
Many other countries, facing similar constraints on their budgets and public debt, have adopted the same kind of model. Both developed and emerging countries have contributed to significant growth in the overall PPP market.
The owner of an infrastructure asset receives regular payments in return for it being operational and available for use. These payments come from a public authority, usually the government. Concessions tend to last for decades and payments are often inflation-linked. Demand and pricing risk is therefore limited.
Yields compare favourably to government bonds. These investments are long-term and government-backed.
Yields compare favourably to government bonds. These investments are long-term and government-backed. As a result, the asset class has attracted significant amounts of capital.
Typically, a special-purpose vehicle (SPV) is set up for each infrastructure project. The SPV is ‘bankruptcy remote’ – legally and financially distinct from its parent entity. Projects are funded by a mixture of long-term debt and equity capital. Debt providers are attracted by the prospect of long-term, stable and reliable revenue streams that such projects can offer.
Equity investors work with construction and facilities management partners to develop and operate projects. The construction company and operator are responsible for the quality of the project and its daily running.
For the equity investor, counterparty risk is an important factor. Equity investors are responsible for any costs incurred by the client if the infrastructure asset is not available for use. For taking on this risk, they typically earn a return of around 7% from operational projects.
The contracts associated with social infrastructure assets tend to be long-dated in nature. They generate predictable cash flows, based on asset availability rather than usage. Backing is provided by governments or regulatory regimes. In many cases, the revenues from each contract are inflation-linked. As a result, social infrastructure can provide investors with particularly strong diversification benefits.
How to access the asset class
Social infrastructure became an asset class offering daily dealing when the first UK-listed infrastructure fund, HICL, launched in 2006. Now investors can access the asset class through a number of listed investment companies that provide equity capital to infrastructure projects. These long-lived assets are well-suited to ‘permanent capital’ vehicles. These companies provide investors with access to infrastructure projects across the UK, Europe, North America and Australia.
RISK WARNINGThe value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.
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