Cover Story: The appeal of infrastructure assets

  • Wan Kamaruzaman: Thorough due diligence and understanding of the regulations, government and demand drivers are crucial when investing in infrastructure.

  • Shahril: We are generally uncomfortable with construction risk, which is why we prefer brownfield assets with a track record and proven cash flow. In cases where we take on some construction risk, we will take steps to obtain the necessary guarantees of performance or hedge those risks.

  • Nor’ Azamin: The need for capital recycling provides the opportunity for a regional infrastructure fund that will allow them to buy into brownfield, operational infrastructure assets with existing cash flows. Hence, this will generate a great appeal for investments in greenfield infrastructure projects.

  • Chow: We expect the Indonesian market to provide some interesting opportunities given the recent passing of the tax amnesty bill, which will see more funds channelled to infrastructure expenditure.
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This article first appeared in The Edge Malaysia Weekly, on November 28 - December 4, 2016.


ASEAN’S need for more utilities, power, roads, sanitation and transport has created a sustained demand for infrastructure assets. This, in turn, has produced an attractive asset class for investors looking for yield and a stable income stream.

While governments continue to allocate funds to this segment, the private sector has stepped up to provide solutions to social needs. Companies involved in billion-dollar infrastructure assets such as utilities and roads have seen profitable returns of 8% to at least 15%.

With the demand for such assets expected to continue growing, there is huge potential to be tapped in the Asean infrastructure market over the next decade, says Maybank Asset Management Group CEO Nor’ Azamin Salleh. “Since the investment needed is massive, Asean governments are working with the private sector to raise capital. This has created a situation of capital recycling, where owners of infrastructure assets may release the capital tied up in their assets to fund new infrastructure projects.

“The need for capital recycling provides the opportunity for a regional infrastructure fund that will allow them to buy into brownfield, operational infrastructure assets with existing cash flows. Hence, this will generate a great appeal for investments in greenfield infrastructure projects.”

Infrastructure assets will continue to benefit from the weak global economic landscape and slow global trade, says Chow Kar Tzen, senior portfolio manager at Affin Hwang Asset Management Bhd. He believes that public investment — a component of the gross domestic product (GDP) — will make up for the weak net exports, personal consumption and private investments (the other three components that make up the GDP).

“This is evident, especially in Asean, where governments continue to ramp up fiscal spending to support growth. We expect the Indonesian market to provide some interesting opportunities given the recent passing of the tax amnesty bill, which will see more funds channelled to infrastructure expenditure,” he says.

Chow notes that while there has been some volatility, there are pockets of opportunities in the Philippine market with the aggressive infrastructure spending targets set by President Rodrigo Duterte’s administration. “Meanwhile, the smooth royal succession has improved market sentiment in Thailand. With this, we believe the infrastructure projects that were identified earlier will take off,” he says.

According to the Asean’s Half a Trillion Dollar Infrastructure Opportunity report published by Goldman Sachs in 2013, an estimated US$228 billion is needed annually until 2022 to meet all the infrastructure needs in the region. The energy and transport sectors are expected to make up 65% of the investments.

Pension funds are also tapping into infrastructure assets. The Employees Provident Fund (EPF) is among those looking into this segment. CEO Datuk Shahril Ridza Ridzuan says when it comes to such investments, the retirement fund usually seeks brownfield assets that are fully operational and have cash flow visibility  

“The long-term nature of these investments has the potential to provide us with a real rate of return, which is in line with our investment targets. The EPF as a retirement savings fund has always focused on delivering sustainable long-term returns by targeting a 2% real dividend over a three-year rolling period,” he says.

The EPF is looking to invest in core infrastructure assets, such as toll roads, airports, seaports, waste management facilities and power plants. Its main criteria when considering an investment is the operational track record, growth prospects and regulatory framework that governs the asset.

In September, the EPF bought a 40% stake in the concessionaire for the Duta-Ulu Kelang Expressway (DUKE) — Konsortium Lebuhraya Utara-Timur (KL) Sdn Bhd — for RM1.13 billion cash. And in November last year, through its wholly-owned company Pinggiran Ventures Sdn Bhd, it bought a 50% stake in Pinggiran Muhibbah Sdn Bhd, a subsidiary of highway and waste company Taliworks Corp Bhd. Pinggiran Muhibbah owns the operator of the new North Klang Straits Bypass.

Kumpulan Wang Persaraan Diperbadankan (KWAP), meanwhile, has indirect exposure to various geographical regions and infrastructure sub-sectors through its private infrastructure funds. CEO Datuk Wan Kamaruzaman Wan Ahmad says these investments include conventional and renewable energy, water and transport.

“We are constantly evaluating opportunities to invest directly in domestic and foreign infrastructure assets and projects. Areas of interest include energy and transport assets as these sectors require the most capital and, hence, are more open to institutional investors such as KWAP. There is also the lure of upside potential and stable returns,” he says.

Nor’ Azamin says Maybank Asset Management favours the energy sector for several reasons. “The high capital requirements create capital recycling opportunities. According to the Energy Outlook for Asia and the Pacific report published by the International Energy Agency in October 2013, the region requires massive amounts of investments in energy infrastructure, with total projected market demand for power in eight Asean countries projected to reach 1,958 terawatt-hour (TWh) by 2035.”

Investing in the energy sector will allow investors to enjoy long-term cash flow predictability, he points out. The regulated nature of the energy sector, coupled with the long-term power purchase agreements, means that the assets’ future cash flow will be highly predictable.

“The energy sector also has relatively lower risk than the other infrastructure sub-sectors as it is exposed to mostly sovereign credits. In addition, some Asean countries, such as Myanmar and Indonesia, have started to price their power purchase offtake agreements in the US dollar, which reduces foreign exchange risk when investing,” says Nor’ Azamin, referring to several studies.

Moreover, investment in the energy sector is inflation-proof, he adds, as most of the power purchase agreements allow for an upward revision of offtake prices by taking into account the inflation rate.

Chow says Affin Hwang Asset Management has a diversified strategy when it comes to investing in infrastructure. “We have holdings in and continue to monitor a relatively diverse infrastructure-related universe, which includes toll roads, airports, energy providers (including renewables), cement suppliers, telecommunications companies and environment-related companies.”

He says its decision to participate depends on the markets and underlying fundamentals of the companies. For example, the company maintains an optimistic outlook on telecommunications service providers in Indonesia given the high-data traffic growth and competition becoming less intense.

Similarly, the oligopolistic advantage that energy providers, toll road owners, cement suppliers and airport concessionaires have make some of these companies an attractive investment, says Chow. “The companies that we have participated in also have a strong balance sheet, which we look out for as it provides the companies with a stronger ability to generate steady cash flow for dividends.”

In an Oct 19 report titled Infrastructure for Growth: The Dawn of a New Multi-trillion Dollar Asset Class, published by Citi GPS: Global Perspectives and Solutions, there is a huge opportunity to invest in this sector globally. It estimates that over the next 15 years, worldwide infrastructure spending to facilitate stronger global economic growth will amount to US$58.6 trillion.

Despite the need for infrastructure, public investment in this sector has been falling in both developed and emerging markets (see graphic). According to a Citi research report, infrastructure could be a much-needed boost to global growth as a 1% increase in infrastructure investment correlates with a 1.2% increase in GDP growth.



What kind of returns can one expect from infrastructure assets? They depend on the sectors and markets the assets are in, says Chow.

“Against the current economic backdrop, we have tilted out portfolio exposure to income-yielding investments. We currently hold a core position in companies that are able to provide both attractive dividends and growth opportunities. We are currently looking at 8% to 12% in total returns from these investments.”

Shahril says the assets that the EPF invests in typically have an internal rate of return of 10% to 13%. The returns depend on such factors as the risk profile of the assets, length of the concessions and stability of cash flow.

“We have gradually incorporated environmental, social and governance (ESG) criteria in our investment parameters, in compliance with the evolving business and investment environment. This effort includes assessing whether the assets are shariah-compliant,” he adds.

KWAP’s Wan Kamaruzaman says the long-term returns from infrastructure investment could be in the high single digits of 8% or 9% for regulated assets in developed markets to more than 15% for a greenfield asset in a developing market.

He adds that the ESG criteria is an important component of infrastructure investment and they need to be carefully assessed early in the due diligence phase. “Thorough due diligence and understanding of the regulations, government and demand drivers are crucial when investing in infrastructure.”

KWAP will also leverage its relationship with experienced and skilled infrastructure fund managers to navigate the inherent risks of these investments, he says.

Shahril says one of the main risks in infrastructure investment is the regulatory framework of the country the assets are in. Thus, a strong and stable regulatory framework is the basis for the EPF’s investment decisions.

“We are generally uncomfortable with construction risk, which is why we prefer brownfield assets with a track record and proven cash flow. In cases where we take on some construction risk, we will take steps to obtain the necessary guarantees of performance or hedge those risks,” he says.

Maybank Asset Management’s Nor’ Azamin says infrastructure investment comes with political and economic risks. There is a possibility that the infrastructure asset could be nationalised following an abrupt regime change in a particular country. There is also the possibility of termination of long-term power purchase agreements. However, this is highly unlikely to happen because of the current energy shortage in Asean, he adds.

“We manage our risks by looking for assets that have operational track records, existing cash flows and long-term contracts with sovereign-backed entities, as well as inflation rate-benchmarked periodic revisions of tariffs, political stability and the strength of local laws and regulations,” says Nor’ Azamin.

Infrastructure funds are most suitable for institutional investors with long-term horizons as there is a need for the capital to be “sticky”, he says. That is because the fund will not exit any of its investments until the end of the tenure.

Affin Hwang Asset Management’s Chow advises investors to understand the assets thoroughly. Potential risks could include budgetary concerns, such as higher than anticipated costs.

“Operational experience, or a lack thereof, could result in a company being unable to make good on promised deliverables. With the higher costs that are generally tagged to infrastructure projects, an interest rate hike will also pose as a risk, given its potential impact on the company’s borrowing cost,” he says.

“Thus, we advocate the importance of understanding the company before making an investment. We continue to focus on fundamentally strong companies and select investments based on a bottom-up stock selection process to mitigate such risks.”



For countries with clear infrastructure needs, efficient public investment processes, spare capacity and accommodative monetary policy, the coming year should give them a fiscal boost, says Lucy O’Carroll, chief economist at Aberdeen Solutions.

“As concerns about the side effects of an ever looser monetary policy have grown, so have the demands for greater fiscal activism. Much has been made of the moves by a small number of countries, including Japan and China, to ease fiscal policy. [There have been] statements of intent by others, including the UK and the US, to do more. Whether they amount to much remains to be seen,” she says in an Oct 13 report, titled Infrastructure spending: What’s not to like?, published by Aberdeen Asset Management.

According to O’Carroll, history suggests that the gains from infrastructure spending can be impressive. Taking a sample of 17 advanced economies, an increase in infrastructure spending equivalent to 1% of the gross national income boosted the level of output by 1.5% four years later.

“So for every pound sterling or dollar a government spends on infrastructure today, it could see a return of £1.50 or US$1.50 in the medium term. As a result, the boost to national income a country gets from increasing public infrastructure investment can, if done correctly, pay for itself without adding to the debt burden,” she points out.

However, the true benefits of infrastructure spending depend on three factors, says O’Carroll. First, there is the amount of “slack” in the economy and behaviour of central banks — where there is plenty of spare capacity, there is also less risk that extra spending will feed into higher prices.

“And when monetary policy is in stimulus mode, interest rates are less likely to rise in response to the pick-up in spending. This reduces the risk that public investment merely crowds out private sector activity, leaving the overall economy no better off,” she adds.

Second, there is the efficiency of public investment. The more efficient the process, from project identification to delivery, the greater the ultimate benefit will be to the economy.

Finally, there is the issue of how the investment is financed. The International Monetary Fund’s (IMF) debt-financed investments have had a greater economic impact than those financed by raising taxes or cutting other forms of spending.

However, despite these factors, public investment has fallen in the developed markets to 3% of GDP from about 4% in the 1980s. While some of the decline may be the result of the private sector’s growing role in infrastructure, such as energy and telecommunications, private investment has also fallen as a share of output in the past three decades, says O’Carroll.

“One fundamental cause lies behind governments’ underwhelming response. Ultimately, infrastructure projects are often large and capital intensive. Upfront costs are sizeable, but the benefits tend to accrue only over the long term. So, where countries’ debt burdens are already high — as many are in the wake of the financial crisis — and the returns on investment drawn out and uncertain, financial markets could take fright,” she says.

“Financing costs could rise, increasing the debt burden and leading to a self-fulfilling vicious cycle. At the same time, concerns about inefficiencies in the public investment process and the contentious nature of some projects may stall some much-needed investment before they even get off the ground.”

Nonetheless, as the IMF has pointed out, it is time for an infrastructure push, says O’Carroll. Public infrastructure investment not only provides a short-term lift to demand, it also helps economies grow faster without hitting capacity constraints. Moreover, increased infrastructure spending could help relieve the policy burden borne by central banks.





Retail investors can buy into infrastructure assets via unit trust funds. For instance, Affin Hwang Asset Management Bhd’s Affin Hwang Select Asia Pacific ex-Japan REITs and Infrastructure Fund gives retail investors access to real estate investment trusts and infrastructure-related stocks in the region.

“We believe that the flexibility of this fund will benefit investors given the current support for income-yielding assets. It has seen a steady growth in interest and has provided investors with consistent returns since Affin Hwang Asset Management took over the management of the fund in March 2012, having recorded an annualised return of 11.8% per annum as at Oct 31,” says senior portfolio manager Chow Kar Tzen.

According to the fund’s fact sheet as at end-October, its top 10 holdings were China Mobile Ltd, CT Environment Group Ltd, HKBN Ltd, Mapletree Greater China, China State Construction International Holdings Ltd, Frasers Logistics & Industrial Trust, Anhui Conch Cement Co Ltd, China Maple Leaf Education System Ltd, Cemex Holdings Philippines Inc and China Longyuan Power Group Corp Ltd.

Chow says the fund’s performance is due to the fund manager’s ability to manage risk and reduce its market exposure to more defensive positions during adverse market conditions. “We believe that it is important to focus on quality investments as we continuously build a portfolio of investments that are sustainable for the medium to longer-term investment horizons of our investors.”

Other infrastructure funds that retail investors can look at include the Hong Leong Asia-Pacific Infrastructure Fund managed by Hong Leong Asset Management Bhd and Public Far-East Telco & Infrastructure Fund managed by Public Mutual Bhd. However, according to the fund factsheets, the funds have registered negative one-year returns of -2.08 (as at end-October) and -10.95% (as at end-April) respectively.





Danny Chang, head of managed investments and products management (wealth management) at Standard Chartered Bank Malaysia, says the bank is keen on some of the spin-off sectors resulting from infrastructure investments, rather than investing directly in the sector itself.

“The whole infrastructure spending that US president-elect Donald Trump spoke about has shifted interest rate expectations and bond yields globally. The 10-year US treasury yield has moved up sharply. It has moved upwards before, but what the market is reading is the stronger inflation expectation this time around,” says Chang.

The stronger inflation expectation is obviously due to talk about the US wage growth — now in excess of 2%. It is not very high, but if you keep in mind that the target inflation rate for the US Federal Reserve is 2% to 3%, it is in the hitting range already, he adds.

Chang believes that wage growth and the employment rate are driving inflation in the US. And this will continue to drive up US treasury yields. Is this sustainable? The employment and wage growth numbers indicate that the trend will continue, he says.

He adds that banking is one of the sectors that will benefit from this trend. “Even the yield curve is moving up in expectation of higher interest rates. One of the sectors that will benefit is the financial sector, particularly in the US.”

That is because banks’ books are funded on the long end using treasury bills or treasury bonds, explains Chang. The banks are used to an annual yield of 1.2% to 1.5%. But post-Trump, this will rise to 2.3% — they are getting almost 100 basis points (bps) of extra yield.

“From there, banks’ balance sheets will improve. So, it is safe to say that the US financial sector will walk away from this as a major beneficiary,” he says.

An immediate effect with the yield curve steepening in the US is that it is a little more attractive to hold US treasury bonds now. Chang says when people start holding treasuries, it means they have to start converting in the US dollar and this will lead to a stronger greenback.

“We are already seeing the spillover happen. A stronger US dollar will be the second beneficiary. With a stronger dollar, needless to say, any asset priced in it — a US dollar bond for instance — will be worth holding on to,” he points out.

However, fixed income comes with the major risk of a yield curve steepening. Chang says when the interest rate or yield curve move upwards, bonds with longer tenors will get hit the most.

“Typically, if you are holding a 10-year bond and the interest rate or yield curve moves up by 50bps, almost immediately, the 10-year bond will see a decline of about 5% — that is the broad rule of thumb.

“Put another way, if you are holding a 10-year bond and the interest rate or yield curve goes up by 100bps, the impact drawdown on your bond will be about 9% to 10%. So, the longer term the bond, the more you will be impacted.”

That is why when the yield curve steepens, investors should not be at the long end of fixed income, says Chang. Shorter-term bonds will be a better choice.

In case the US inflation rate does carry through, investors may want to hold real assets as they typically provide better inflation protection than paper assets, says Chang. He adds real estate could be one sector that will benefit from the yield curve steepening. But this is obviously going to happen over a longer-term cycle, say, beyond two years.

Nonetheless, there are ways to play the real estate game without actually buying properties, says Chang. For instance, investors can buy mortgage-backed securities (MBS).

The MBS may be agency or government-backed, as opposed to non-agency or non-government-backed. During the subprime crisis, the MBS were not government-backed. Chang suggests that investors consider US government-backed MBS as a way to access real estate in the US.

“With US employment nearly full and interest rates still low, the risk of a default for these underlying MBS is going to get lower. Separately, another risk of MBS is prepayment risk or early settlement of these mortgages by the borrower. With US interest rates not expected to fall, the prepayment risk will also be lower — a positive for the MBS investor,” he says.