A comprehensive guide on infrastructure development
What is infrastructure development?
Infrastructure developmental investing is a sub-sector of developmental investing, and can also be called impact investing. Developmental investing provides investors with both commercial returns and a tangible social and developmental impact. In South Africa, the primary development focus is around the provision of basic services - and infrastructure development focuses on sectors such as power, healthcare, transport, education, small, medium and micro-sized enterprise development, and housing, to name a few.
Why does infrastructure development matter right now?
Recent figures released revealed that the South African economy contracted by 3.2% in the first quarter of 2019[1] relative to the first quarter of 2018, with the agriculture, mining and manufacturing industries showing the most significant decline. This 3.2% decline is the largest drop in economic activity since the first quarter of 2009 (where a contraction of 6.1% was recorded), while the entire world economy was reeling from the effects of the global financial crisis.
Source: Statistics South Africa
This weak economic environment further adds to the societal challenges faced by many South Africans, particularly those with no access to essentials like clean running water, electricity, affordable healthcare or a good quality home. And this brings the importance of investments that further develop and improve the country’s infrastructure assets to the fore. More than 20 years into our country’s democracy, this task needs to be taken on by both the public and private sector in order for a meaningful change to happen.
How do we do this?
Our flagship Futuregrowth Infrastructure & Development Bond Fund, which aims to make investments that facilitate infrastructural, social, environmental and economic development in South Africa, has been in existence since January 1995. Through this and a variety of our other client funds, we, as fiduciary asset managers, are attempting to address the country’s infrastructure development needs by investing in businesses that operate in the following sectors, amongst others:
As previously stated, the pace and magnitude of infrastructure development is a key contributor to a country’s economic growth prospects. And while government continues to communicate its commitment to investing more in the country’s infrastructure backbone[2], it must be emphasised that the private sector also has a role to play in ensuring that the necessary capital is channelled into this extremely important area, which should drive the much-needed growth in the South African economy.
Defining infrastructure development and understanding the impact that it can potentially deliver is perhaps the easier part, and the hard work comes in when one attempts to identify the appropriate partners to invest in, and which sectors to focus on. As asset managers, we are tasked with responsibly deploying our clients’ capital while delivering on the developmental mandate and ensuring that our clients earn returns that are in line with the risks identified.
Choosing partners to invest in
Investment analysis should – whether from a debt or equity perspective - focus on both quantitative and qualitative factors, where the analyst’s responsibility involves identifying the risks that could lead to a loss in the value of the capital invested.
As part of the Futuregrowth credit process, the initial pre-screening is typically the point at which we decide whether or not to proceed to doing a deep due diligence on a transaction. And because we are predominantly debt providers, we aim to protect our clients’ capital against the downside risk on the transactions that we participate in. Factors assessed typically include, amongst others:
- historical financial performance;
- a forward-looking view of the business operations and its sustainability;
- the extent to which there is alignment of interests between all stakeholders of the business;
- management’s experience and track record;
- the composition of the board of directors, including their skills and experience;
- an assessment of the environmental, social and governance factors that could affect the risk profile of the business; and
- understanding the competitive environment and industry in which the business operates.
As lenders, our main focus is on doing the analysis/research and applying our minds as best we can to ensure that the businesses to whom we decide to lend money will have the capacity to repay the capital provided and service the interest charged to them. Essentially, what is of utmost importance is understanding what could potentially cause these businesses to go under.
While businesses that are in the infrastructure development space can be exposed to some quite specific risks, the key for us is that the fundamentals should still hold and the returns generated for our clients’ funds must be commensurate with the risk taken on.
Have our investment decisions actually yielded returns?
Over the past few years, there have been some notable defaults and debt restructures in both the South African and global markets, which is testament to the fact that creditors do in fact default and lenders need to negotiate meaningful protections to avoid losing capital in a default scenario. The benefit of spreading risk through portfolio diversification means that the impact of any such default or debt restructure should not be as adverse as it would have been if the exposures in the fund were more concentrated.
The Futuregrowth Infrastructure & Development Bond Fund has a commendable performance track record and over the long term has outperformed its benchmark, the All Bond Index.
Futuregrowth Infrastructure & Development Bond Fund performance
At 30 April 2019
Source: Futuregrowth
At the end of April 2019, the fund was exposed to a variety of sectors with almost 50% invested in transactions in the infrastructure development and social services space. Measurable social returns have included the provision of affordable housing in urban areas, the supply of renewable energy, access to finance for small enterprises, improved transport infrastructure, healthcare and shopping facilities in rural areas, development of farmland and the creation of jobs in rural areas, and many more.
Social impact sectors at 30 April 2019
Source: Futuregrowth
In conclusion
Investing in infrastructure development benefits the country’s overall economy and generates social returns that can be quite meaningful and tangible. And importantly, we seek to generate this social return while also ensuring that our clients earn risk-adjusted commercial returns.
In his 2019 State of the Nation Address, President Cyril Ramaphosa noted that: “Government has committed to contribute R100 billion into the Infrastructure Fund over a 10-year period and use this to leverage financing from the private sector and development finance institutions.” And with our country’s ailing economy, it is important - now more than ever - for the public and private sector to work together on addressing the issues that are holding back our economy.
[1] “Economy stumbles in the first quarter” – published on 4 June 2019. Source: http://www.statssa.gov.za/?p=12200
[2] “Infrastructure act will go a long way to realising Cyril Ramaphosa's goals — if only he would use it” – published on 4 March 2019. Source: https://www.businesslive.co.za/bd/opinion/2019-03-04-infrastructure-act-will-go-a-long-way-to-realising-cyril-ramaphosas-goals--if-only-he-would-use-it/
“Infrastructure at the heart of Ramaphosa’s plan to boost the economy” published on 21 September 2018. Source: https://mg.co.za/article/2018-09-21-infrastructure-at-the-heart-of-ramaphosas-plan-to-boost-the-economy
