Asia’s infrastructure needs are vast. But for over 20 years the region has failed to entice much international investor capital to help meet them. The quality of most projects simply hasn’t been high enough, and the political risks of investing into Greenfield projects are too great.
That could be set to change, courtesy of China’s Belt and Road Initiative. Announced by President Xi Jinping in 2013, the project is designed to strengthen intra-regional integration between China and countries in Eurasia and beyond.
The initiative doesn’t lack for ambition. Belt and Road’s geographic coverage encompasses 68 countries in Asia, Africa, the Middle East, Europe and Oceania. Combined they represent one third of global gross domestic products (GDP) and trade flows, two thirds of the global population, and a quarter of global foreign investment flows, according to a Moody’s report released in September.
For Beijing, Belt and Road combines soft-power outreach and economic stimulus. It will help Chinese companies sell construction materials and engineering to approved projects, underpinned by loans from Chinese banks. And the new infrastructure should help the country move its exports more easily, said Gabriel Wong, head of China corporate finance at PwC.
For institutional investors, the initiative could offer potential investments. But participating directly will be no easy task.
“I think it [Belt and Road] is a watching brief for our team; it’s not something they are particularly actively involved with at the moment. We would be expecting our managers to understand the environment, and if they thought there were some good opportunities that they would bring them to us and raising them,” David Neal, chief executive of Australia’s Future Fund told AsianInvestor.
AsianInvestor talked to several asset owners and fund managers to understand their needs and learn how they to bridge the gap between needy infrastructure projects and investor requirements.
Their responses give cause for hope, over the long term. While risks cannot be mitigated completely, global investors have the potential to gain infrastructure returns if they are patient and find the right partners.
The financing needs of the Belt and Road are huge. China’s policy banks, commercial banks and funds dedicated to the project had invested approximately $190 billion into such projects by the end of 2016, said Mark Rathbone, Asia leader of capital projects and infrastructure at PwC.
But Belt and Road-linked projects need over $1 trillion in additional funding. And emerging Asia countries, most of which are on the route, require $26 trillion—or $1.7 trillion a year—of infrastructure investment by 2030, according to an Asian Development Bank (ADB) report released in February.
To date, governments or multilateral institutions have funded around 90% of regional infrastructure. But future needs are so vast that more money will have to be sourced from private capital, said Ben Way, Asia chief executive at Australian bank Macquarie, speaking at conference in London on September 21.
Added to this, 80% of institutional capital sits in the West, while 80% of the infrastructure needs lie in emerging markets, noted Ram Mahidhara, chief investment officer for infrastructure at IFC, part of the World Bank, at the same conference.
The challenge is to funnel some of the latter into the former. Shifting just 10% of the $100 trillion-plus held by pension funds, sovereign wealth funds, insurers and others into infrastructure would be a big boost, Mahidhara said.
To date, emerging market infrastructure investments have proven too risky for most institutional investors, even though they often offer appealing returns.
Under current global environment, the target annual return for core, mature or stable-income infrastructure projects is 7% to 9%, while it stands at 9% to 11% for growth infrastructure. The target return for Greenfield (new-build) or opportunistic infrastructure is even higher at 12% or more, said consultancy Willis Towers Watson.
The main trouble with emerging market infrastructure is risk. The projects are often based in sub-investment grade countries and are Greenfield to boot, or new projects that need to be built.
That means long investment time horizons, often 20 years or more, substantial risk of construction delays, and a risk that the country’s government will change during the project’s lifespan, with a new one declining to honour the agreed contractual terms.
These risks are particularly true of infrastructure deals in less developed markets like Bangladesh, Indonesia and Vietnam. Investors are leery of having to lend money for long periods into countries such as these, which appear less predictable over longer periods of time from a political and regulatory perspective, said Macquarie’s Way.
Over $750 billion is spent on Asian infrastructure each year, but there are very few “good projects” to invest into within this, added Vijay Pattabhiraman, chief investment officer of Asian Infrastructure assets at JP Morgan Asset Management. Even leading asset owners have steered clear of such investments.
Speaking at the same conference as Way and Mahidhara, Alain Carrier, head of international for Canada Pension Plan Investment Board (CPPIB), said the fund made some investments in emerging market greenfield deals but added that it was not a key area of focus for the pension fund.
Li Keping, senior adviser and former chief investment officer of China Investment Corporation (CIC), echoed the view.
“For purely commercial investors, it [emerging market Greenfield investing] is very tough,” he told the annual meeting of the International Forum of Sovereign Wealth Funds (IFSWF), held on September 6 and 7 in Astana, Kazakhstan.
Even China’s Silk Road Fund (SRF), which was established in 2014 with AUM of $40 billion explicitly to invest into Belt and Road projects, finds it tough. It has over 100 potential projects to consider, but sorting out worthy ones is not easy, said managing director Luo Yang, at the same conference.
He pointed to potential issues such as the political stability of the host country, as well as some countries’ weak legal frameworks and government inefficiency.
Virginie Maisonneuve, chief investment officer of Eastspring Investments told AsianInvestor a similar point. She noted that government-backed institutions, multi-laterals, Asian relationship banks, in-country sponsors and infrastructure funds have all pledged or raised capital for Asian infrastructure investment.
But countries need to offer strong regulatory support, together with structuring and execution capability to generate commercially viable assets.
“Those unfortunately have not developed at the same pace as capital allocation,” Maisonneuve said.
Look out for part two of this AsianInvestor September/October magazine feature on China's Belt and Road initiative and infrastructure investing, in which we consider the best ways to promote more institutional funds into Greenfield projects.