infrastructure SIFs

nTmA Act 2014, simply states that the fund should invest “on a commercial basis in a manner designed to support economic activity and employment in the State.”23 ISIF’s 2015 investment strategy elaborated by providing a list of 10 eligible investment sectors, an indicative portfolio allocation by sector based on estimated funding gaps (which helped determine ISIF’s size), and commentary on the rationale for each sector’s selection (ISIF 2015).

Box 5.2 provides a sense of the decision tree for SIFs focused on infrastructure as they identify the sectors of focus within the broad remit of the sponsor. mixed capital SIFs whose investors include pension and other institutional funds may prioritize brownfield over greenfield investments. In general, pension funds opt to invest in large, mature operating assets that already yield cash flow.24 As a condition to investing in a SIF, institutional investors may therefore require the SIF itself to prioritize less risky assets. Such risk aversion may be heightened when a SIF is managed by a newly assembled investment team, as opposed to an external fund manager with previous experience. Conversely, free of such constraints, public capital SIFs have greater flexibility to pursue riskier investments on the asset maturity and income generation spectrum.

BOX 5.2

Investment strategy: Snapshot on defining investment scope for infrastructure SIFs

For strategic investment funds (SIFs) focused on addressing infrastructure gaps, a rigorous definition of their infrastructure investment scope is an important component of the investment strategy. SIFs should consider the following parameters in defining the scope:

• Identifying a range of subsectors: – Infrastructure sectors with monopolistic characteristics (toll roads, ports, airports, utilities, water treatment facilities, power generation plants that sell power to utilities under offtake agreements). Projects in these sectors produce fairly predictable cash flows, driven by regulated tariffs paid by infrastructure users and long-term concession agreements (for example, the marguerite funds and India’s national Investment and Infrastructure Fund [nIIF]). – Infrastructure sectors exposed to competitive forces (telecom providers, merchant power plants, logistics and infrastructure services companies). Competition exposes businesses in these sectors to a variety of risks, such as loss of market share or pricing power, which makes them riskier and more volatile investments (for example, marguerite and nIIF). – Enabling infrastructure, or sectors at the crossroads of services and infrastructure, which can contribute meaningfully to the overall economic development of a country (health care, education, financial services companies specializing in infrastructure). The nigeria Sovereign Investment Authority’s nigeria Infrastructure Fund has invested in private schools, cancer treatment and diagnostic centers (under public-private partnership models), an infrastructure debt fund, and an infrastructure bond guarantee company.a • Identifying stage of development—the extent to which, at the time of investment, the infrastructure assets are already constructed—and

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Box 5.2 continued

income profile—whether the project already generates income and cash flows. Infrastructure investors commonly categorize projects as greenfield, brownfield, or secondary stage.b – Greenfield project refers to an infrastructure asset that does not exist at the time of investment. The project may be in the planning, development, financing, or construction phase. Investors fund the building of the asset and its maintenance once it is operational. A greenfield project does not generate income—rather, it absorbs capital— during the development and construction phases. Income generation is delayed until the asset becomes operational. Investors therefore assume construction risk (such as unexpected delays or costs) and must have a sufficiently long investment horizon. The additionality of greenfield projects may be easier to justify for

SIFs. Greenfield projects not only require new capital for development and construction but are also less palatable to existing institutional investors. Both funds managed by Marguerite, while retaining the flexibility to invest in brownfield projects, focus on greenfield investments. – Brownfield project refers to an existing infrastructure asset that requires improvements, repair, or expansion; is usually partially operational; and may already generate income. Brownfield investments are usually less risky and require a shorter investment horizon. The additionality of brownfield investments can vary greatly, depending on the required infrastructure improvements, repairs, or extensions (and the related capital), which can be substantial (for example, in the case of restructuring of stranded assets, or greenfield additions). The additionality of a SIF’s investment in brownfield projects

may also reflect a country’s overall macroeconomic conditions. Marguerite invested in a shadow toll road in Spain after the global financial crisis, when high risk aversion toward the country limited capital inflows from private capital funds. – Secondary stage refers to a fully operational asset that requires no investment for further development and already generates a steady income stream. These assets are sold in the secondary market by investors looking to exit their investments. The additionality of secondary stage projects may be less obvious but cannot be ruled out. For instance, a SIF may pursue a secondary transaction to demonstrate the feasibility of infrastructure investing in its country, or as the first step of a broader strategy to inject significant capital into the country’s infrastructure sector. NIIF’s Master Fund invested in Continental Warehousing, a terminal and logistics business previously controlled by three private equity funds, by using a special purpose vehicle (“platform,” in NIIF’s terminology) established to scale up investment in port infrastructure in India, crowding in capital at both platform and project levels. DP World, the Dubai-based port terminal owner and operator, injected capital in the platform company, of which it owns a 65 percent stake.

A SIF may later shift its positioning on project stage and income profile. For instance, NIIF first launched its Master Fund, which focuses on brownfield infrastructure projects. It subsequently concentrated on mobilizing commercial capital for a Fund of Funds, which focuses on indirect investments via existing or new infrastructure funds. Finally, it launched its Strategic Fund, targeting a broader range of investment strategies including greenfield investments with a long investment horizon of 20–25 years.

Source: Based on Della Croce 2011 and Preqin, n.d.; see also the case studies in appendix A. a. The Nigeria Sovereign Investment Authority’s Nigeria Infrastructure Fund portfolio companies are listed in the case study (see appendix A). b. Definitions vary slightly across the literature; this study draws on those of Della Croce (2011) and Preqin (n.d.).

• Target geography.Because a SIF must comply with a policy mandate, its target geography is typically consistent with the domicile and policy objective of the public sponsor(s). SIFs with sovereign sponsors usually prioritize investments in the sponsor’s domestic market. In contrast, the geographic scope of

SIFs backed by a multilateral public sponsor or a group of bilateral sponsors from different countries can be broader—for instance, covering a continent, a political or economic union of countries, or a specific set of countries. In the case studies, all SIFs backed by a national sponsor invest exclusively or predominantly in their domestic markets: FOnSIS invests in Senegal, ISIF in

Ireland, nIIF in India, and nSIA-nIF in nigeria. ACP (backed by the AdB) has a pan-Asian mandate. nonsovereign sponsors may still impose geographic restrictions. For instance, marguerite funds—backed by the european

Investment Bank and the development banks of several eu member states— allow no more than 20 percent to be invested in a single eu member state and no more than 5 percent in preaccession member states.25 Some SIFs backed by a national sponsor can also invest abroad. Their foreign investments, however, must be consistent with the domestic policy mandate, and will most likely represent a fraction of the portfolio. For instance, ISIF can make foreign investments if they are on a commercial basis and can have a tangible economic impact in Ireland; examples include investments in foreign venture capital funds that commit to back Irish companies. note also that some SIFs are allowed to invest excess liquidity in the international capital markets.

These investments are for capital preservation purposes and need not comply with the double bottom line mandate. FOnSIS, for instance, is allowed to invest up to 25 percent of its assets (net of statutory reserves) in liquid, creditworthy foreign securities (see the case study in appendix A). • Capital instruments. The investment strategy should clearly specify the instruments of focus. different layers of the capital structure have different risk/return profiles and require different investment procedures and contractual documentation. The composition and skills of the investment team vary accordingly. SIFs in principle can invest in any capital instrument, if the investments offer the potential for commercial returns and, in compliance with the additionality principle, address a capital gap in the mandated sectors. direct investments could include senior and subordinated debt, equity, and various forms of mezzanine capital (see box 5.3 for brief definitions of these instruments). Indirectly, SIFs can also invest in funds that focus on these instruments. Like PCFs, mixed-capital SIFs, whose investors include institutional ones, may have to select either equity or debt as their primary focus, in line with the emergence of private equity and private debt as distinct asset classes. • Majority versus minority equity investments. For SIFs that focus on direct equity investments, a critical element of the investment strategy is determining whether the fund can take majority or minority interests in portfolio companies (or has the flexibility to do both). The size of the ownership stake in a portfolio company is a key determinant of the level of activism of a fund, in addition to the structure of the investment and the jurisdiction in which the portfolio company is located (Invest europe 2018). Table 5.2 provides a breakdown of target stakes of case study SIFs, and box 5.4 provides a breakdown of generally used investor protection provisions in shareholder agreements.