To move beyond the limitations that can arise from a domestic investment approach, there are compelling reasons for institutional investors to look beyond North America. A global approach to infrastructure investing can provide multiple benefits to investors, including global demand for infrastructure, enhanced diversification and significant deal flow.
1. Global demand for infrastructure
Globally, there is a sizeable infrastructure investment gap. The World Economic Forum estimates the funding gap to be approximately US$1.0 trillion each year.
Local governments alone are unlikely to narrow the gap given rising debt levels, austerity measures and an overall decline in public funding over the last few decades. These funding shortfalls and changing regulatory regimes create growing opportunities for private sector investors.
2. Enhanced diversification
Broad diversification across geography and asset class is important for any portfolio of infrastructure assets as each asset type and geography will have its own unique risks and merits. Limiting a fund’s investments to a single region or country inevitably amplifies the portfolio’s risk to regional factors such as local regulation, economics, demographics and political influences.
Figure 1: 2016 infrastructure deal by sector
Similarly, a portfolio that’s heavily skewed towards a single asset class, such as GDP-based ports and/or airports, could potentially be at risk of exposure to sector-specific headwinds, such as a global downturn in trade. Therefore, a broadly diversified global investment mandate with a thoughtful approach to building out the infrastructure portfolio will better optimize the diversification of such risks. By optimizing portfolio diversification and providing investors with the broadest set of investment opportunities, a global mandate has the potential to increase investors’ ability to realize risk-adjusted portfolio returns over the long term.
3. Access to deal flow
Given the importance of deal flow in creating investment opportunities, a global allocation can provide more attractive investment opportunities than domestic markets alone.
With a longer investment history, non-North American infrastructure markets are well developed, particularly in Europe. Data and intelligence company Preqin estimates that, in the past five years, 59 per cent of infrastructure deals have taken place in Europe and Asia, while North America accounted for only 27 per cent of deals.
Figure 2: 2016 infrastructure deals by region
Different countries may have more robust infrastructure assets in certain sectors, which is a critical factor when constructing a portfolio. Some examples of sector leadership include Britain in water utilities, North America in power generation and Australia in privatized airports.
In addition to a broad set of developed market exposure, infrastructure investors should also consider incorporating emerging market assets into their portfolios. Emerging market allocations have the potential to enhance expected returns and widen the opportunity set in investments.
The decision to select domestic or global infrastructure exposure can have a material impact on investors’ ability to diversify portfolio returns and access the broadest set of investment opportunities. Country risk can be materially higher than sector risk due to the degree of government dependence as the user and/or regulator of infrastructure assets. As such, geographic diversification can play an important role in mitigating country-specific risks.
Whether investing in infrastructure for the first time or re-assessing current infrastructure allocations, institutional investors may wish to consider a global approach that provides exposure to a larger opportunity set to deploy capital into high-quality, long-term deals.