- Hong Kong’s equity market has been booming recently. Knowing that I manage investments at the HKMA, a friend asked during dinner if I had any “hot picks”. I told him that our investment objective is not to engage in speculation. When I was about to illustrate how we are seeking opportunity in long-term investment frontiers, my friend showed no signs of enthusiasm and switched topics immediately. While there was nothing I could do about that, I decided to reach a wider audience at inSight and share with our readers an investment area that is becoming more popular these days – infrastructure.
- From the Xianyang courier route of the Qin Dynasty to all the roads that led to Rome, infrastructure can be regarded as one of the oldest asset classes. Infrastructure investment and operation were usually done by governments in the past. While there was private sector participation, the scale had been far smaller than their investments in other asset classes. However, infrastructure has gradually become a hot topic in the investment arena in recent years for it can bring about long-term and stable return. In this article, I would like to discuss the background of this development and the characteristics of infrastructure investment. I would also briefly touch on the Exchange Fund’s participation in this area.
Strong demand from around the globe
- Infrastructure generally refers to basic facilities, such as energy and power, transportation, water supply and sewage treatment that are essential to economic development and people’s livelihood. In addition to long investment period and huge capital requirement, infrastructure projects usually involve issues such as the development of large parcels of land and the relocation of residents. Therefore, investment in as well as construction and operation of infrastructure were primarily conducted or led by public sector entities in the past. The main reason that made infrastructure investment a hot topic within the investor community recently is the supply and demand gap between investable opportunities and available capital. In some advanced economies, infrastructure was built several decades to a hundred years ago and is becoming obsolete. Readers who frequently travel to Europe or the US may notice that the quality of infrastructure in some of their cities is even worse than that of some developing countries. This has created a knock-on effect and has been slowing down economic and social development. The infrastructure in these cities is badly in need of redevelopment or refurbishment. The most notable example is the US. Both the Republican and Democratic Parties realise the importance of investing in infrastructure. The Trump administration has promised to introduce a US$1 trillion rebuilding plan to rejuvenate the nation with world-class infrastructure.
- There is also strong demand for infrastructure development in developing countries, albeit for different reasons. Some of these countries’ social and economic development is still in its infancy. They require investment in basic infrastructure projects to unleash their growth potential. Some other developing countries, such as those in Southeast Asia, have experienced rapid economic growth in recent years and find that their infrastructure (such as power supply) cannot keep up with the growing needs and may even become bottlenecks for further enhancements to productivity. Without improvements, economic growth will be stifled.
- The abundant supply of infrastructure projects leads to demand for capital. According to projections made by a renowned consultancy, countries from around the world need to make as much as US$49 trillion on infrastructure investment from 2016 to 2030 in order to maintain stable economic growth. Of this amount, around 60% needs to be invested in emerging markets. Should investment in infrastructure projects be maintained at the current level, it is expected that there would be a funding gap of over US$5 trillion in the coming 15 years. At the same time, according to an estimate by the Asian Development Bank, the total amount of infrastructure investment in Asia alone will be over US$20 trillion from 2016 to 2030.
- Where will the money come from? Traditionally, infrastructure projects are funded by public sector entities such as governments and international development agencies (e.g. World Bank, Asian Development Bank). However, the huge funding gap, coupled with the fact that public finances in many countries are already under pressure, will make it difficult for the public sector to further allocate large sums of capital towards infrastructure spending. Moreover, based on past experience, the public sector has much to learn from the private sector in commercial viability assessment, budget control, operation flexibility and so on. As a result, the Public-Private Partnerships (PPP) model, which brings together investors through multiple channels, has become a common approach adopted by governments to stimulate infrastructure investments. Yet, are investors interested?
Steady return attracts public and private sector investors alike
- Spurred by a strong global demand for infrastructure investment, participation by public sector and private sector institutional investors as well as multilateral organisations on this front has become increasingly active. A number of large private equity fund managers are ready to invest in or have already committed actual funds to various infrastructure projects. Since its establishment within the HKMA in mid-2016, the Infrastructure Financing Facilitation Office (IFFO) has brought together numerous sovereign funds, international development agencies, large-scale pension funds, insurance companies and other major investors from around the world within the span of a year. These players all share optimism about the prospects of infrastructure investment.
- Astute investors are only drawn to true gems. What is it in infrastructure investments that attract them?
Firstly, investors are looking for high-quality investment opportunities amid ample liquidity in the current market environment. As I have mentioned in an inSight article published in January this year, “Exchange Fund: Looking Ahead – A Combination of Prudent and Proactive Approaches to Achieve Long-Term Growth",
“The investment return of the Long-Term Growth Portfolio has been satisfactory. However, with more and more investors joining the alternative asset bandwagon, quality investment opportunities have become more difficult to come by. This has in turn exerted pressure on the return. Therefore, we are actively exploring new frontiers, which include industries that can counter inflationary pressures, have a low correlation with traditional asset return, offer good potential for growth, and provide a continuous cash flow, e.g. infrastructure. ”
While the above subject is the Exchange Fund, the quest is in fact shared by many investors.
- Another attractive attribute of infrastructure investment is the stable return and cash flow that it offers, especially PPP projects which enable participants to lock in long-term return and cash flow usually through long-term operating contracts awarded by governments. Moreover, as infrastructure constitutes an essential part of people’s livelihood, its return is less affected by economic cycles. For institutional investors awash with capital, such as insurance companies, sovereign funds and pension funds, the characteristics of infrastructure investment are very much in line with their own stable and long-term investment strategy.
- Of course, infrastructure investments carry specific risks, including commercial viability, political and economic risks of relevant jurisdictions, as well as environmental and sustainability concerns. Therefore, appropriate arrangements and measures must be in place for stakeholders to assess, mitigate and avert those risks.
- Infrastructure investment projects are characterised by a very long investment horizon, easily spanning ten or twenty years, and involve huge upfront capital outlays. For projects requiring multi-billion US dollar investment, only world-class institutions with strong financial standing have the capacity to participate. Further, they will usually line up with other institutional investors to share the risks. Many private sector institutions aspire to team up with some international organisations to take part in these projects, partly taking advantage of the multi-governmental backing that these organisations have, which helps mitigate the political and economic risks. It is also because these international organisations will properly address environmental protection, sustainability, procurement procedures and other governance aspects of investment projects to meet the generally higher standards of today's world. Following close exchanges with many infrastructure stakeholders at the IFFO platform, a reference term sheet has been developed through reaching a consensus on the mitigation measures for various risks associated with infrastructure investment.
Long-term growth at acceptable risk levels
- Following our in-depth research on infrastructure investment and concept crystallisation on the IFFO platform, the Exchange Fund is now ready to embark on this area of investment. As with other types of investment, we will as always be prudent when making any investments in infrastructure. In particular, we will take the following measures:
Infrastructure investment will form only a part of the Long-Term Growth Portfolio of the Exchange Fund.
Each investment must be commercially viable, carefully examined in preparatory studies and must undergo rigorous due diligence. Priority will also be accorded to jurisdictions with proper governance and environmental protection framework.
Appropriate measures will be taken to avoid undue concentration in a particular region, investment type, investment horizon and other attributes.
We will seek to partner up with like-minded world-class investors to give full play of our respective professional expertise.
- In summary, our infrastructure investment strategy is to seek long-term growth within acceptable risk levels. There has been good progress so far in our search for suitable investment projects, with some projects coming close to fruition. I look forward to sharing with you some good news shortly.
Deputy Chief Executive
Director of Infrastructure Financing Facilitation Office
Hong Kong Monetary Authority
19 September 2017