Infrastructure is gaining acceptance as an investment style. Some observers even recognize it as a separate asset class. I’m a financial purist wedded to the traditional breakdown of three asset classes – equity, fixed income, and cash – with everything else falling into some subset of those three. Even the hard asset things I’ve inspected recently like REITs are a form of equity ownership despite the similarity of their cash flows to a debt instrument. I want to determine whether infrastructure really does belong in its own asset category.
Fitting infrastructure into a financial taxonomy begs the question of how ownership in such an asset is structured. Equity is outright ownership, albeit with a residual claim after creditors in the event of liquidation. Ownership of bridges, airports, prisons, inland waterway locks, and other infrastructure assets that support management of “the commons” typically resides with government entities. Privately owned assets used for public purposes are rare exceptions to this state, but there are such things as private toll roads in Texas. Infrastructure plays are thus rarely subject to outright ownership interests that are tradable in the capital markets.
Investors already have exposure to infrastructure investments through fixed income instruments that municipalities issue to finance development. Anyone who wants a piece of this action can buy airport bonds, Tennessee Valley Authority power bonds, and securities from state development authorities that build roads and bridges. I’m not fond of bonds at all right now due to the strong likelihood that the US will experience sudden hyperinflation in the near future. Infrastructure investors who select bonds may get burned even if government agencies raise usage fees to maintain the physical assets. Bonds pay a coupon fixed as a percentage of their face value. Hyperinflation reduces that fixed value to nothing, with a similar reduction in the real purchasing power of that coupon payment. Increases in usage fees to keep up with hyperinflation may cover little more than physical maintenance of infrastructure; bond investors will get a pittance in real terms. Covenants in those bonds may allow issuers to call them at par, enabling them to stick it to bondholders during inflation and retire enormous debt piles at minimal cost.
On the other hand, private equity investors in toll roads, airports, bridges, and other infrastructure assets need not bother with bond covenants. They can raise usage fees at will because control of infrastructure gives them pricing power over consumers who have little alternative but to use the asset. I suspect that private equity ownership of infrastructure is the only form of ownership that fully utilizes an inflation hedge.
The emergence of special treatment for infrastructure owes much to the never-ending quest among professional investors for something new and exciting. Every investment bank wants to stand out from the pack to keep deal flow coming. The OECD recognizes infrastructure as a special case for the largest institutional investors. I just don’t think it’s a special enough style to merit its own asset class.