Real-AssetsMedium

3 min read · 512 words

What the seat actually does

These funds own physical assets that produce a stream of payments: toll roads, electricity networks, pipelines, airports, wind farms, data centres, warehouses, farmland. The money comes from people using the thing, and the seat's work is mostly about the arrangement under which they pay.

The asset is rarely the risk; the contract is. A wind farm with a twenty-year offtake agreement at a fixed price is a bond with turbines attached. The same wind farm selling into a spot power market is a commodity position. Identical steel, completely different investments.

• Contracted — somebody has agreed to pay, for years, at a known price.
• Regulated — a regulator sets an allowed return on the capital invested, and the risk is the regulator rather than the customer.
• Merchant — the asset takes market price and volume risk, which is a different asset class wearing the same word.

A day, and where it goes

• Origination — auctions, secondary stakes, and construction projects that do not exist yet.
• The model — thirty years of cash flow, and a debt structure sized off it. See project finance.
• Technical and regulatory diligence, which is where the specialists are and where the surprises live.
• Asset management — running the thing, or overseeing whoever does, for a decade or more.

What it is measured on

• Yield, and how contracted it is. A distribution that depends on traffic volumes is worth less than the same distribution under a availability payment.
• Inflation linkage — many of these contracts are indexed, which is much of why the asset class is bought at all. See inflation.
• Debt service coverage — the constraint that sizes the whole structure.
• Long-horizon returns, which means marks matter more than usual because so little is ever sold.

What it touches on this site

• The financing — project finance and structured finance.
• The instruments — infrastructure funds and property funds.
• What the revenue is exposed to — commodities when the offtake is merchant power, and inflation when it is indexed.
• Where the leverage sits — where the leverage hides.

How it goes wrong

• Construction. An asset that does not exist yet has a completion risk that no operating model captures, and it is the single largest source of loss in the class.
• The regulator changes the allowed return. A political decision arrives as a valuation event.
• Merchant exposure sold as contracted. The word "infrastructure" covers both and they are not the same product.
• Refinancing risk at the end of a long structure, when the market for that debt may not exist on the day it is needed.

Concepts to master

• Contracted, regulated or merchant. Ask this first; the answer determines everything else.
• Availability versus demand risk. Being paid for the road being open is a different business from being paid per car.
• The debt is sized on coverage, not on a multiple — see the structured finance desk.
• Long duration cuts both ways. Thirty years of indexed cash flow is exactly as rate-sensitive as it sounds.