Building roads in emerging markets no zero-sum game

Building infrastructure fit for the 21st century in emerging markets is forecast to require a trillion dollars a year in additional financing.

Although it is a daunting task, it has become a high priority for Gavin Wilson. As chief executive of IFC Asset Management Company, a subsidiary of the International Finance Corporation, Wilson has a pivotal role in encouraging institutional investors to address the yawning gap in infrastructure investment.

“What are the bottlenecks to economic growth around the world? Most of the time the answer to that lies with infrastructure. It is difficult to underestimate the importance of this sector for global development,” says the 52-year-old.

Speaking at a conference in London this month, Wilson challenged the audience to rethink their ideas about infrastructure, which he believes many see as investible assets in developed countries that deliver safe but low returns.

In his view, that perception needs to change. He points to the fact that, since the start of the millennium, the IFC, the private sector investment arm of the World Bank Group, has delivered returns above 20 per cent a year on average on its equity investments in emerging market infrastructure.

Default rates for private sector infrastructure loans in emerging markets are only marginally higher than comparable transactions in the developed world, he says. “The perception of risk is much higher than the reality,” complains the former Goldman Sachs banker.

Wilson feels a new definition of infrastructure is needed, but admits the investment gap will not close anytime soon without changes in the relationship between private investors and host governments. Trust remains an issue, he says.

“When it comes to the crunch, the fundamental problem with financing infrastructure is that the private sector does not trust the public sector and the public sector does not trust the private sector,” he says.

Given the perception among investors that the rule of law does not hold in emerging markets in the same way it does in developed markets, Wilson believes a rating system should be created to assess countries’ regulatory risk, akin to sovereign credit ratings.

This would deter governments (in developed and developing countries) from making unilateral changes to contract terms, he says.

“If the trust factor can be improved, this will reduce the perceived risk of an infrastructure asset, which will lead to cheaper financing, lower project costs and therefore lower tariffs for end consumers,” says Wilson, who moved to Washington in 2009 to set up the IFC’s asset management unit (AMC).

AMC manages $8.1 billion across seven funds and one fund of funds. This makes it one of the three largest private equity fund managers focused on global emerging markets. Of this, AMC has so far invested $4.6 billion in 60 companies. Four more funds are in the process of being launched.

AMC’s pitch to investors is to offer selective access to the IFC’s investment pipeline. The IFC has made well over 2,000 equity investments in developing countries over 60 years. It coined the phrase “emerging markets” in the 1980s.

“AMC has the right, but not the obligation, to participate in the IFC’s transactions,” he says, adding that the asset management business runs a separate investment decision-making process and owes its fiduciary duty to its investors, which include sovereign wealth funds and public and private pension funds.

In practice this means AMC chooses to invest in a small subset of IFC deals, running at about 20 transactions a year.

Since the IFC was founded in 1956, the capital committed by its member countries amounts to just $2.5 billion. By reinvesting the profits from maturing investments, the IFC has grown its net worth to $24 billion. It has also contributed more than $3 billion in grants to the International Development Association, its sister organisation that funds public sector projects in the world’s poorest countries.

The IFC has developed a “remarkably consistent” equity track-record, he says, that places it comfortably in the top quartile of emerging market private equity investors.

“The best way to demonstrate to investors that they should invest in emerging markets is to make good risk-adjusted returns. Projects that do well financially tend to be those that also successfully deliver benefits to local economies,” says Wilson.

He maintains that profits and development impact “are not two separate things” but self-reinforcing. He also calls the integration of environmental, social and governance considerations with investment decisions “simply good business”. He cites the IFC’s recent decision to fund a wind farm in Panama, which will provide 5 per cent of the country’s energy needs, as an example.

Wilson has high expectations for AMC’s other investment vehicles, such as the IFC Capitalization fund. The fund has invested in the equity and subordinated debt of commercial banks in the years following the financial crisis, when capital for banks was sorely needed.

Emphasising the importance of building diversified asset portfolios, Wilson says there is “a strong case” for investors looking for exposure to emerging markets to allocate capital to private investments rather than listed securities. “Capital markets in the developing world are often less advanced,” he says.

Ahead of a series of three UN conferences later this year, where the issue of finance for development will feature prominently, Wilson says the IFC wants to make sure there is “strong representation” by private business and finance. There has sometimes been insufficient direct communication between policymakers and those making investment decisions.

“This year will be a critical year of bold ambition for global development. It must also be the year we bring private investors into the equation to attract the capital required to make it all happen,” he says.

— Financial Times