Building Monopolistic Positions: The Appeal of Infrastructure Investments
Institutional investors have been allocating a growing share of their portfolios to infrastructure assets—including regulated utilities, transportation and contracted power. The focus has been on core investment strategies, which can produce stable, forecastable yields through the use of prudent leverage and some combination of transparent and consistent political, regulatory environments, long-term contracts with credible counterparties, and mature demand profiles. Most core infrastructure assets have monopolistic positions in the markets they serve, so prices and usage are relatively insensitive to periods of economic weakness. Instead, core infrastructure investments are driven by a different—and uncorrelated—set of factors, including regulatory risk, development risk, operational risk and leverage. Many core infrastructure assets are natural monopolies by design.
For some assets, such as regulated utilities, alternative providers are forbidden by the government. For others, such as transportation assets, alternative routes are often distant and time-consuming. The monopolistic position of these assets makes the demand for their services resilient to economic downturns and fluctuating prices. Core infrastructure assets also utilize long-term contracts. Power generation assets can protect themselves from volatile power markets through long-term contracts with utilities, corporates or governments. The contracts, which can last as long as thirty years, establish very stable cash flows in return for the asset’s availability and generation. Since core infrastructure investments have reduced exposure to market demand, their risk-return drivers are relatively uncorrelated with other asset classes.
Environmental, Social, and Governance (ESG) Criteria
Infrastructure investing is inseparable from ESG principles, as infrastructure investors necessarily take a long-term view and so focus heavily on prudent and sustainable business practices. First and foremost, running a business and executing on a strategic vision require competent management, abetted by an independent and experienced board of directors. Successful construction businesses tend to have a philosophy of continuous business improvements, reinforced through active asset management by a company’s owners. Infrastructure shareholders are responsible for implementing the structural changes needed to promote a company’s long-term growth, rather than relying on discount rate fluctuations to paper over weak internal controls. That means infrastructure investors must promote board-level engagement and oversight, management accountability, transparency of performance, and ethical employee conduct.
Infrastructure investments are critical for the transition to an environmentally sustainable economy. The retirement of fossil fuel–based power plants is contingent on tremendous new investment in renewable energy. Significant up-front capital is also necessary to provide electricity networks with smart grid technology, to reduce water leakage, and to upgrade ports to promote energy efficiency and intermodal transport. As long-term owners, infrastructure investors cannot be blind to the future impact of climate change on individual assets and government policies. Infrastructure investments are in physical assets, and so have an inherently local component. Utilities have defined service areas, while power plants and transportation assets have tangible footprints. As a result, infrastructure investments depend on investors’ relationships with local regulators, customers and communities. Through close attention to ESG principles, infrastructure investors not only encourage sustainable development, but can also bolster their own financial performance.
Working closely with colleagues in complementary practices, such as Corporate Finance and Private Equity, our global network of consultants brings deep expertise and innovative analytical tools to each project. Our Infrastructure Practice serves investors—including infrastructure funds, pension plans, sovereign wealth funds, insurance companies, banks, development banks, national infrastructure banks, and high-net-worth individuals— throughout the life cycle of an investment. We strive to create investment solutions that preserve the capital that millions rely on for their financial future.