Asset owners are waking up to the infrastructure opportunity as developmental and commercial credit converges

There was a time when one could draw a clear distinction between two categories of credit investors – those seeking to make an impact, like development finance institutions, and those seeking to achieve good returns, like banks or fund managers. Now, however, as sustainability and ESG considerations become increasingly important for asset owners, banks and fund managers, we are witnessing a convergence of developmental credit and commercial credit, particularly in infrastructure. As the focus on climate and the road to net zero intensifies, so too is the imperative for pension funds to extend their focus beyond the narrow parameters of risk and return to a broader remit incorporating risk, return and impact. At the same time, it has become apparent that the return on developmental lending is higher than expected, mainly due to a lower loss experience. It is no longer the case that to contribute to development and invest sustainably, investors must accept much lower returns.

Development finance institutions were at the forefront of this convergence, as they sought to ‘crowd in’ commercial investors, structuring investments with a more commercial mindset. Blended finance – the use of development finance for the mobilisation of additional finance towards sustainable development in developing countries – has blossomed, initially with different tranches of debt into the same projects, where developmental lenders take more risk.  Increasingly, however, we are seeing commercial and developmental lenders side by side as commercial investors see the opportunity to invest sustainably, while still achieving good risk-adjusted returns.

The magnitude of the infrastructure gap

This convergence of commercial and developmental investment has come at the right time for South Africa, given the enormous backlog of infrastructure spending. The primary constraint, and thus need, is debt funding, and that is where the largest opportunity lies. Most infrastructure projects are owned by government, state-owned enterprises or larger corporates, so there are limited opportunities for equity investing. But almost every project needs debt. In addition, even where equity is available, credit makes up the bulk of funding in most projects.

According to the National Development Plan, South Africa should be spending at least 30% of GDP by 2030 on infrastructure in order to promote inclusive economic growth. Unfortunately, as Figure 1 shows, spend has tracked well below this target since the early 1980s, and South Africa significantly lags other faster growing economies. Compared to the rest of the world, we are in the bottom quartile of gross fixed capital formation (GFCF) as a percentage of GDP, with the World Bank estimating it at 13.7% in 2020. In stark contrast, China’s GFCF as a percentage of GDP was over 42%.

Our woefully inadequate investment in critical infrastructure such as energy, rail, road, ports and housing, has been one of the contributing factors to poor economic growth in South Africa. With better infrastructure comes inclusive growth and prosperity, as well as global competitiveness, which South Africa dearly needs.

Figure 1: The infrastructure investment gap in South Africa

Source: South African Reserve Bank

Recent steps by government and industry bodies are laying the platform to correct this imbalance, and commercial credit investors are starting to wake up to the infrastructure opportunity. However, South Africa is still some way behind other emerging markets, where there has been a clear shift towards providing debt to non-cyclical businesses. The OECD Survey of large pension funds, for example, estimated that the South African Government Employees Pension Fund has total exposure to infrastructure of only 1.2%, versus its Brazilian counterpart’s (the Brazil Previ) allocation of 5.1%^¹. According to Willis Towers Watson^², the seven largest markets for pension assets (Australia, Canada, Japan, the Netherlands, Switzerland, the UK and the US) had an allocation to private markets and other alternatives of just 7% in 2000. That allocation has risen to over a quarter of assets (26%) by 2020.

Importantly, the growing recognition that debt can be sensibly deployed into physical assets at scale while meaningfully contributing to South Africa’s future growth, does not imply a sacrifice in returns. On the contrary, infrastructure investment can deliver uncorrelated and attractive risk-adjusted returns, while channelling capital into the real economy to support growth and deliver a measurable impact.

As Mercer^³ points out in their research on the asset class, infrastructure assets have intrinsic value, given that they tend to be quasi-monopolistic and provide essential services to society. They provide predictable steady cash flow with low volatility and a low correlation to other asset classes.

A promising pipeline

South Africa has historically faced significant infrastructure investment challenges, from low levels of government support through to lack of investor capability and capacity, and a lack of pipeline. Now, however, the landscape is improving at a rapid pace. Not only has government instituted numerous policy reforms, but this has coincided with a wealth of private and public sector investment expertise able to cater to a deep savings pool eager to invest in infrastructure.

The government’s infrastructure investment plan presents ample opportunity for private investment, representing an investment value of more than R2.3 trillion in over 200 projects. As Figure 2 shows, these span all sectors from transport, water and energy to human settlements and ICT/digital communications.

Figure 2: SA government’s infrastructure investment plan – projects per sector

Source: National Treasury, 2021 Budget Review

Positioned to navigate the convergence

The convergence between development and commercial finance is almost perfectly mirrored by the evolution of the Ninety One SA & Africa Credit team, which combines strong private and listed commercial credit experience, with deep infrastructure expertise.

Ninety One’s SA & Africa Credit team was started in 2005, when credit was identified as a growth opportunity and as a distinct asset class. Today the team manages numerous strategies across illiquid and liquid credit, including sixteen vintages of the Credit Opportunities Fund, closed-ended funds that focus on private and illiquid credit in South Africa and the rest of Africa. Infrastructure was identified as a key sector from the start, and has been an important building block of the Credit Opportunities strategy. In 2016, Ninety One was appointed to manage the Emerging Africa Infrastructure Fund (EAIF), a public-private partnership anchored by the governments of the United Kingdom, The Netherlands, Sweden and Switzerland. EAIF is an initiative of the donor-financed Private Infrastructure Development Group and was established in 2002 to mobilise capital into private sector infrastructure projects across sub-Saharan Africa. The Fund subsequently established itself Established as a market leader in infrastructure finance in Africa, and currently has over US$1 billion in drawn and committed exposure to numerous sectors including renewal energy, ports, water, manufacturing student housing and logistics.

The EAIF team of infrastructure specialists were brought on board within the SA & Africa Credit team, alongside the commercial credit specialists. The benefits of integrating the two teams were immediately apparent, with their similarities in coverage and approach far outweighing any differences. The team also benefits from dedicated legal, ESG and development impact specialists.

Over a period spanning two decades, the Ninety One SA & Africa Credit Team has invested R58 billion in infrastructure, with a rate of deployment of approximately R7 billion per annum, supporting more than 130 projects and borrowers. Today, infrastructure accounts for close on half of all general illiquid debt strategies managed by the team.

South Africa has a critical need to invest in infrastructure, both as a primary boost to activity and as a facilitator of growth for the wider economy. There is an enormous funding need, which will require both commercial and developmental lenders. On the commercial side, banks will not be enough and fund managers and asset owners are critically important if we are to achieve the required investment. The convergence of commercial and developmental objectives comes at the perfect time: South Africa has a deep savings pool, which if channelled effectively, would not only be able to achieve commercial returns, but also dent unemployment and meaningfully address inequality and poverty. To succeed, we will need to see a collective effort between government, asset owners, asset consultants and the investment management industry. And for asset owners to meaningfully participate, they will need fund managers who have the necessary experience – managers who have had their own convergence of developmental and commercial expertise.

Download PDF

¹ https://www.oecd.org/daf/fin/private-pensions/Survey-of-Large-Pension-Funds-2021.pdf
² https://www.thinkingaheadinstitute.org/research-papers/global-pension-assets-study-2021
³ https://www.mercer.com/content/dam/mercer/attachments/global/gl-2021-infrastructure-a-primer.pdf