Vital Importance of Risk Management in Infrastructure Projects

5-vital importance of risk management

#ActiveAllocator Opinion – We strongly advocate  both greater upfront as well as ongoing risk analysis to catalyze infrastructure development. The fundamental drivers of infrastructure revenues are changes in macroeconomic factors such as GDP and demographic trends. Growth in these factors increases usage-based revenue and positive cash flows for these assets. Infrastructure assets typically feature a set of common attributes which provide for defensive investment characteristics.

There are three key criteria that dictate the risk/return characteristics of infrastructure to a large extent:

Stage of Maturity

Investment in assets under construction is riskier than completed assets; investment in newly completed assets with no operating history (including usage) is riskier than investment in mature assets with established operations and usage history.

Geography

Political risk in developing countries is a key consideration given the essential nature of the assets to the local economy, the long life of the assets and the fact that they cannot be moved, making them vulnerable to expropriation. To mitigate this risk, many investors target only developed countries or developing countries with robust legal frameworks, particularly with respect to property protection and contract enforcement. The long payback period also increases the probability that an investment may be adversely affected by a period of severe economic instability (e.g., government default, hyperinflation). In compensation, many emerging markets are enjoying significant economic growth, which has strong direct benefits for infrastructure businesses.

Sector Scope

All else being the same, infrastructure businesses whose revenues are not subject to price and/or volume variations are less risky than those that are. Some social infrastructure PPP companies (e.g., for hospital facilities) may be paid by the government on an “availability basis,” e.g., revenue is independent of usage and the service is compensated at a fixed price, with deductions only for poor service. Where there is volume risk, this may be mitigated by the nature of the service (e.g., provision of water to a given area) and/or by the monopolistic nature of the asset (e.g., being the only airport for a major city). Price risk may be mitigated by regulation that periodically determines price to provide a certain return on capital (e.g., for utilities) and/or by fundamental demand (e.g., for a toll road for a major corridor). To the extent that price and volume risk is not significantly mitigated, the asset may not be considered to be “infrastructure” for investment purposes. For example, power generators that sell electricity into a market at spot prices (e.g., it is “merchant” generation with no long-term power purchase agreements) is considered ineligible by many infrastructure investors.

Author: Sameer_Jain

Partner. Sameer Jain is founder of FinTech ActiveAllocator.com, the world’s first portal that seamlessly integrates traditional, illiquid and alternative investments within portfolios. Prior to this he was Chief Economist & Managing Director at AR Capital. Before that he headed Investment Content & Strategy at UBS Alternative Investments. At UBS, he served as a non-voting member of the Wealth Management Research investment committee, and as a capital allocator was responsible for all illiquid investing including fund manager selection and due diligence across the platform. Prior to UBS he headed product development & investment research at Citigroup Alternative Investments that managed over $75 billion of alternative investments across hedge funds, managed futures, private equity, credit structures, infrastructure and real estate. Here he led a team that developed proprietary models for portfolio strategy and asset allocation with alternative investments, provided investment support and research to pension plans, sovereign wealth funds, endowments as well as internal clients including Citi Private Bank. Before this he was with Cambridge Alternative Investments and SunGard (System Access) where he travelled to over 80 countries for work across Europe, Asia, Middle-East and Africa. He has written over 30 academic and practitioner articles on alternative investments with thousands of downloads at SSRN, presented at over a hundred industry conferences and has coauthored a book, Active Equity Management. Mr. Jain has multiple degrees in engineering, management, public administration and policy and is a graduate of Massachusetts Institute of Technology and Harvard University. He is a recipient of the Alfred Sloan Fellowship and subsequently was a Fellow of Public Policy and Management at the Harvard Kennedy School of Government for a year. He holds Series 7 and 66 securities licenses.

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