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Social infrastructure plays a critical role in economic activity, productivity and social welfare. We could define it 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 rolling stock. But it only recently became an investable asset class when the first UK-listed infrastructure fund, HICL, launched in 2006. Historically, the public sector (local and national governments) was responsible for creating and maintaining such buildings and services.
With public funds limited, social infrastructure companies help to provide better public services through operational efficiencies.
Changing demographics have made infrastructure even more of a priority for governments globally. With public funds limited, social infrastructure companies help to provide better public services through operational efficiencies. They also allow for the transfer of risk to the private sector.
Public-private partnerships (PPPs) and private finance initiatives (PFIs) use private capital to develop vital social infrastructure in the UK. Introduced in the early 1990s, their usage increased in 1997. This surge in popularity coincided with the election of a new Labour government and they became the preferred funding method for large infrastructure projects. Over the past 20 years, over 700 projects have used 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/PFI market.
Investors are attracted by the fact that social infrastructure projects are mainly availability-based. 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 a government. Demand or pricing risk is therefore limited. Concessions tend to last for decades and payments are often inflation-linked.
Long-term, government-backed cashflows and yields that compare very favourably to those of government bonds have attracted significant amounts of capital to the asset class.
Usually, a special-purpose vehicle (SPV) is set up to provide access 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 favour the security offered by the long-term, stable and reliable revenue streams from such projects.
Equity investors work with construction and facilities management partners on development and operational 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 therefore an important factor. Equity investors are responsible for any costs incurred by the client, should the infrastructure asset not be available for use. For taking on this risk, they typically earn a return from operational projects.
We access the asset class through listed, closed-end investment companies which provide the equity capital for infrastructure projects. Such long-lived assets are well-suited to these ‘permanent capital’ vehicles. Trading on listed markets, these companies provide investors with access to a wide range of critical infrastructure projects. Locations range across the UK, Europe, North America and Australia.
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. Because of this, we think social infrastructure provides investors with particularly strong diversification benefits.