Infrastructure Over the Long Term

As the pandemic wreaks havoc across the globe, does this structurally change the outlook for long-term assets, such as infrastructure? We speak with Aberdeen Standard’s Head of Economic Infrastructure to find out.

Infrastructure investing is a long-term game, where investors often seek to understand how an asset’s cash-flow profile will develop over a period of 30 years or more. But few investors would have considered the impact of a pandemic on their portfolio.

The coronavirus and the subsequent lockdowns the world has experienced since March have not affected all assets in the same way.

There are clearly those assets that have been significantly affected and those that have proven to be more resilient, Dominic Helmsley, Head of Economic Infrastructure at Aberdeen Standard Investments, says in an interview with [i3] Insights.

“If you look at the relative impact of the COVID pandemic, parts of the transport sector have been significantly impacted, where as an investor you are taking demand risk. Most dramatically affected, of course, are the airports and the associated auxiliary services,” Helmsley says.

Helmsley and his team don’t own any airports as they were already concerned about the volatility of these assets before the pandemic hit. But the team has now decided to move away from the asset class altogether until the impact of the pandemic is fully understood.

“In the midst of the COVID crisis, it is difficult to form a view on future aviation demand and so it is hard to really value an airport accurately at the moment. Consequently, we have changed our view on that and we are moving away from the asset class in the near term,” Helmsley says.

Ports are another tricky asset, but the outlook for port assets, particularly in the United Kingdom is a bit better than for airports, since the country will still need to import goods in the foreseeable future.

“The port sector is driven by GDP and, clearly, we are in a depressed economic environment. We are trying to second guess how that is going to play out. We are not really sure,” Helmsley says

“Obviously infrastructure is a long-term asset class so in the very long term, you’d have to assume as an island nation that port traffic will recover and provide a reasonable level of economic activity. But being precise about that is incredibly hard.”

What makes the situation more difficult in the UK is the fact the country is also in the midst of Brexit, which is soon to come into force. It is unclear how this will affect import and export demand over the long term.

“You will see people being more cautious in pricing port assets. I think airports are almost impossible at the moment,” Helmsley says.

Railways

Aside from the clear losers in this pandemic, there are a raft of assets where the impact has been mixed. Toll roads are a good example, Helmsley says.

“Toll roads have suffered something of a decline, depending on the exact nature of the jurisdiction. But interestingly, a lot of toll road traffic has recovered. People are keener to get back in their car and more reluctant to get onto public transport,” he says.

“There has been an increase in private car usage, which has helped compensate for the lower demand that has been coming this way. So toll roads are in this mid-space.”

Then there are those assets that have behaved exactly as investors hoped they would: they’ve shown resilience in pricing, while continuing to provide a steady yield.

“Where we’ve seen resilience is in availability-based investments. We have investments in the rail space, which are currently being underwritten by the UK government, despite the fact that ridership of trains and public transport in the UK has significantly declined,” Helmsley says.

The railway sector has been a key area of investment for Helmsley and his team. They have formed a partnership with Rail Rock, a provider of financing and asset management services for train rolling stock.

The partnership grew out of the privatisation of the British railway system in the 1990s, where the government appointed companies to operate the tracks and provide new trains.

“The trains, which were previously owned by the state, were basically quasi gifted to three companies. Those companies, Eversholt, Angel Trains and Porterbrook, are known as ROSCOs (rolling stock companies). They inherited these trains and it was their job to lease these trains to the franchisees,” Helmsley says.

“The original models suggested that those leasing companies would be encouraged to buy new trains and replace the fleet over time. But in reality, what the ROSCOs discovered was that it was much cheaper to simply refurbish old trains with a lick of paint and some new seats and then put them back on lease. This was much more profitable than purchasing a new train.

“Over time the DFT (Department for Transport) recognised that and became much more draconian in determining when new trains should be introduced. So around 2010, the franchise model began to change and the DFT, as the granting authority, began to insist that on certain new franchises, the operator must introduce new trains.

“And really at that point we saw an opportunity, alongside a couple of colleagues that used to work alongside me at Babcock & Brown.

“Babcock & Brown acquired one of these ROSCOs, Angel Trains, in their European infrastructure fund, and therefore had expertise in the sector. And these individuals recognised that there was an opportunity to really disrupt that market and provide a new financing solution to operators of the new trains that were required to be introduced.

“That was the genesis of our partnership with Rock Rail in 2014 and then we began bidding to operators who were in turn bidding in the DFT franchise competitions.

“It still took us quite some time to break the market. We bid on a number of franchises and operators over the course of 2014 and 2015. So we invested a lot of time and risk capital into this joint venture, but eventually we were successful on the first of our fleets, which was a new set of trains to run out of Moorgate station in London on suburban routes to the north.

“That was around about GBP250 million of capital investment and that really opened the eyes of the other operators of what was possible. And very quickly after that, we secured two further franchises: one was with Greater Anglia for Swiss-built, new electric express trains. That was for circa GBP750 million.

“And then again relatively soon after that [we got] a big order of circa GBP1 billion worth of new Bombardier suburban trains to run out of Waterloo station serving south-west of London. So it cascaded quite quickly that we had an attractive, long-term financing solution and we were more competitive than the ROSCOs, and very quickly we captured 10 per cent of the UK market for passenger trains.”

Expanding the Model

Aberdeen Standard Investments is now looking to export this model to the European mainland, where the European Union is pushing the liberalisation of the railways.

“Having invested a lot of time in the Rock Rail team in the UK, the partnership has evolved and we’ve now taken the model to Europe where we see a very exciting range of opportunities. We are currently doing the early work of establishing ourselves and establishing a presence in various European jurisdictions,” Helmsley says.

“The whole of the European railway system is being liberalised under something that is called the Fourth Railway Package, which is a collection of EU legislation designed to open up the railways to competition.

“And so we’ve been bidding on various fleets of trains in Spain, Netherlands and elsewhere. But we are very close, we think, to winning our first fleet of trains in Europe in Germany.”

The implicit guarantee of governments for public transport networks, such as railways, makes the investment less dependent on fluctuations in demand, which during this pandemic has turned out to be a blessing, especially since there is little clarity about when passenger traffic will recover or whether it will ever recover to the same level as before the pandemic.

“It is not quite clear what the passenger recovery rates will be in railways. The journey on a London commuter or underground train was frequently overcrowded before the COVID crisis and so can you imagine people getting back onto trains in those sorts of volumes?” Helmsley says.

“Maybe in a world where there is a vaccine and COVID goes away, maybe we do return to that.

“But maybe passengers will demand a higher degree of comfortable spacing in a post-COVID world. And that means you either need the same number of trains and fewer passengers or you need more trains.

“Right now, we don’t see a major negative impact today on public transport and railways, but trying to second guess the level of future demand is difficult.”

Technological Change

In a world where technological development seems to be ever increasing, long-term assets, such as infrastructure, are susceptible to disruption. An often cited example is whether the world needs as many car parks as we currently have if self-driving cars are one day going to take off.

With the rollout of 5G across the globe, self-driving cars are getting closer to becoming a reality as more devices can be connected to the Internet of Things. Helmsley doesn’t see this as fanciful thinking and considers disruption a real risk in infrastructure investing.

“It is definitely something we need to consider. Infrastructure is a long-term asset class and we typically price assets on the basis of a 30-year cash-flow projection. Within our funds, we look to hold assets for at least 12 years, so it is a long-term game. You have to take on board, to some degree, the future evolution of the marketplace,” he says.

And it doesn’t even have to be self-driving cars that could disrupt an asset such as car parks, he says.

“Car parking would be hugely disrupted by something like self-driving cars, or whether it is the advent of an Airbnb-type of model, where you allow people to park on your driveway and, thereby, disrupting the commercial parking operators,” he says.

But when it comes to infrastructure portfolio changes spurred on by technological change, Helmsley looks closer to home and is currently interested in the rollout of the fibre optic network in the UK.

“In the UK, and a number of European jurisdictions, there is an interesting theme where in the more rural areas there are some subsidies available for individual homes and also an overlay of a voucher scheme,” he says.

“What is interesting about that is that it takes you into a world where you are not competing to take fibre into London or Bristol, but into market towns and smaller towns. There is a series of regional players who have emerged and are installing fibre into these smaller towns of around 10,000 to 30,000 people.

“They will secure subsidies for a number of connections and so the investment is underpinned by the government subsidy. So it is an interesting play. It is something we haven’t invested in, but we are actively looking into.”

This article is paid for by Aberdeen Standard Investments. As such, the sponsor may suggest topics for consideration, but the Investment Innovation Institute [i3] will have final control over the content.

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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.