Infrastructure as an Asset Class
As asset class is a group of assets that have similar investment characteristics amongst themselves. At the same time, their investment characteristics are different from other asset classes. For instance, all stocks share certain characteristics amongst themselves, which they do not share with bonds. Similarly, there are certain characteristics that infrastructure also has as an asset class. These are the characteristics that make infrastructure financing an attractive investment option for investors.
Infrastructure as an Asset Class
All financial instruments related to infrastructure financing have come common characteristics regardless of whether they are debt-based, equity-based, or even options. An investor needs to understand some of these characteristics before deciding whether to put their hard-earned money in infrastructure financing.
The defining characteristics of infrastructure as an asset class have been listed down in this article.
- High Barriers to Entry:
- Inelastic Demand:
- Economies of Scale:
- Tax Benefits:
- Long Gestation Period:
- Low Sensitivity To Economic Swings:
Infrastructure projects generally comprise of public works projects. As a result, companies that bid for such projects are required to have a good amount of technical expertise in the relevant field as well as deep pockets. In many parts of the world, political connections are also required in order to land such projects. Hence, it would be fair to say that there are high barriers to entry in this field. As a result, if a company already has the approvals in place to implement an infrastructure project, investors are generally keen on investing their money. This is because of the fact that such projects have very little competition and hence provide stable, predictable cash flows.
Infrastructure projects are usually in industries where demand is very stable and does not change drastically in relation to small changes in price. For instance, people who pay for toll roads derive a lot of utility from their usage. They are unlikely to stop using the facility because of a minor increase in price. Also, in many cases, toll roads are the only option. Hence, demand is totally inelastic. Other infrastructure projects such as dams, power plants, ports, etc. also have an inelastic demand. This characteristic makes infrastructure financing an attractive investment class.
Infrastructure projects are generally undertaken on a large scale. As a result, the company undertaking the project stands to benefit from economies of scale. For instance, when a company lays down a telecom network, it pays a fixed cost. The marginal cost of adding another subscriber to the network is almost negligible. This factor, along with economies of scale, means that investors stand to make hefty profits from infrastructure projects. In most cases, infrastructure projects only face limitations from the supply side. There is a significant amount of demand for such projects. This makes infrastructure financing a preferred asset class.
Infrastructure financing is a priority for many countries worldwide. As a result, governments try to make it easier for infra companies to raise money. Hence, many tax breaks are provided to infrastructure companies all over the world. So much so, that tax breaks have become a synonym for infrastructure financing. These tax breaks are the reason that infrastructure-related investments provide a higher yield to individuals as well as to businesses.
Infrastructure projects are supposed to have a very long life. Roads, bridges, dams, and railway lines last for several decades. In fact, in many cases, infrastructure projects may take a decade or so to build. During the build phase, the project does not generate any revenue. However, the project still survives because of the long life of the debt which has been floated. Infrastructure finance bonds generally have a very long duration. A lot of times, perpetuities are used to finance such projects. Infrastructure projects have a long life, stable cash flows, and limited ability to generate returns. It is for this reason that many infrastructure companies use a lot of leverage in order to accentuate the return on their investment.
Lastly, one of the most important characteristics of infrastructure financing is that it has a very low sensitivity to economic swings. In simple words, this means that even if there is a recession, the number of people using infrastructure projects, as well as the revenue generated from such projects, remains more or less unchanged. This characteristic is very important for many investors since it allows them to use infrastructure to diversify their portfolio. Infrastructure financing can be accommodated in a portfolio where equity and debt are already present. When equity rise, debt falls, and vice versa. However, infrastructure-related instruments tend to remain stable regardless of the rise and fall in other investments. As a result, it can be used as a defensive financial instrument in a portfolio.
The bottom line is that infrastructure financing has some very attractive characteristics, which has helped it emerge as an important alternative investment asset class. Most funds across the world have some amount of money invested in infrastructure assets.
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