Real and perceived obstacles to infrastructure investment are falling away

by Thabo Khojane | 5,Nov,2023 | Investments, Ninety One, Q4 2023

Real and perceived obstacles to infrastructure investment are falling away

Thabo Khojane, Managing Director, Ninety One South Africa

South Africa has faced significant infrastructure investment challenges, from low levels of government funding capacity to investor concerns about governance, to a lack of project pipeline. Now, however, the landscape is improving at a rapid pace. Not only has government instituted numerous policy reforms, but this has coincided with growing investment expertise able to cater to a deep savings pool.

However, there is a perception that retirement funds are reluctant to invest in infrastructure, based on theoretical obstacles ranging from liquidity concerns to regulation as reasons to steer clear. Many of these arguments are in our view unfounded. Firstly, it is a myth that retirement funds do not invest in illiquid assets like infrastructure. Yes, it is true that South African retirement funds need some level of liquidity in order to pay benefits. However, according to FSCA annual reports, during the 5-year period to the end of 2020, retirement funds paid out an average of -8% of assets in benefits. This was balanced by an average of +6% of assets as contributions, which meant that their net-flow position was a manageable -2%. Retirement funds typically have cash exposure of 5% to 10% of assets. In addition, we believe that the direction of travel is for net outflows to reduce over time, due to compulsory annuitisation, which started in 2021, and compulsory preservation, which is scheduled to start next year.

Secondly, contrary to a narrative that regulation has discouraged investment into unlisted assets (and therefore unlisted infrastructure assets), retirement fund regulation has long been an enabler of investment into unlisteds. The old Regulation 28 allowed for aggregate exposure to unlisted assets (excluding property) of up to 35%. The revised Regulation 28 allows for aggregate exposure to unlisted assets of up to 40%.

While unlisted equity provides the catalytic energy to get projects off the ground, the larger opportunity for retirement funds lies in unlisted credit (or private debt), which typically exceeds the equity required for projects. While the equity upside is forgone, unlisted credit has several attractive features for retirement funds. Firstly, valuation of private debt is objective and stable. Secondly, the investment ranks ahead of equity in any downside scenario, meaning improved recovery and a narrower and more predictable range of outcomes. Furthermore, unlisted credit earns semi-annual or quarterly interest payments and receives amortisation payments over the life of a loan, while the maturity date of a loan also provides a clean exit without the need to take market or resale risk.

Finally, we know that governance has not been an obstacle for many retirement funds to invest in unlisted infrastructure assets; they have a long history of doing so. Large retirement funds, in particular, have the advantage of scale. They can afford specialist investment expertise and advice, as well as a well resourced governance model which at times includes full time in-house investment experts. Good examples of existing unlisted infrastructure investments by retirement funds include:

  • Energy and power such as renewable energy projects under the Renewable Energy Independent Power Producer Procurement Programme (REIPPPP).
  • Transport such as the N4 Maputo Corridor and Bakwena toll roads.
  • Water such as the Trans-Caledon Tunnel Authority (TCTA) projects.
  • Telecommunications infrastructure such as data centres and fibre optic cables. Teraco, for example, has grown to become the continent’s preeminent provider of data centres. Openserve, a subsidiary of Telkom Limited, forms the backbone of South Africa’s fibre internet, pivotal in enabling both nationwide and global connectivity. Maziv, a provider of fibre connections to telecommunication providers and internet service providers.
  • Affordable housing such as student accommodation and entry-level homes like those provided by Balwin (a property developer), service a growing and previously underserved segment of our population. This infrastructure provides essentials such as access to clean water, internet connectivity, efficient utility services and social recreational activities.
  • Gas infrastructure such as the Republic of Mozambique Pipeline Investments Company (ROMPCO), a joint venture between the governments of South Africa and Mozambique, and Sasol, facilitates the transportation of natural gas from gas fields in Mozambique to markets in both Mozambique and South Africa.

So, does this mean that the only persisting obstacle to even higher exposure in retirement funds is the absence of new government-sponsored infrastructure projects? Perhaps, but even this obstacle might soon be removed when Infrastructure South Africa (ISA) starts to roll out new projects. This programme within the Ministry of Public Works and Infrastructure oversees the project preparation, appraisal and evaluation required to package a credible and market-ready infrastructure project pipeline. The programme forms the bedrock of South Africa’s Infrastructure Investment Plan and the National Infrastructure Plan 2050. Another important potential enabler of new infrastructure projects is the Infrastructure Fund, housed in the Development Bank of South Africa (DBSA). Seeded by National Treasury to the tune of R100 billion, it is intended to catalyse R1 trillion of infrastructure delivery over the next three decades.

However, regardless of how quickly or slowly government is able to roll out its much talked about pipeline of infrastructure projects, we already have a large and growing universe of infrastructure investment opportunities. Retirement funds should grasp the opportunity to participate in this exciting growth vector.

Thabo Khojane
Managing Director at Ninety One South Africa | + posts