Bonds and Infrastructure

Traditionally, if the bond market rallies there would be a flight towards infrastructure-based companies. We often receive a number of requests to explain the relationship between the bond market and the infrastructure sector.

Bonds are explained in more detail by following this link

The term infrastructure, as generally understood, covers the capital required to produce economic services from utilities (like electricity, gas, telecommunications and water) and transport works (like roads, bridges, urban transit, seaports and airports). They are central to all economic activity.

The major listed infrastructure stocks in Australia include Transurban Group, Macquarie Infrastructure Group, Macquarie Airports, Babcock and Brown Infrastructure and Transfield Services. Essentially these companies hold interests in the likes of the above.

Typically the projects undertaken display the following characteristics:

• Large and elaborate
• Long operational life (with a long investment payback period),
• Economies of scale,
• High initial costs,
• Are "lumpy investments",
• Provide "essential" services,
• Networked delivery system,
• Bearing the above in mind, it follows that the financing aspect of the projects are crucial in the success or otherwise of the project.

Banks play an important role in this process by raising the amount of finance available for infrastructure development, as does the access to the equity and capital markets. A number of mechanisms for financing infrastructure investment exist. Their suitability depends on the ownership/operation model selected. These include:

• Finance from government borrowing
• Borrowing through banks
• Borrowing from domestic capital markets (including long term infrastructure bonds),
• Borrowing on international capital markets (via bonds once more)
• Equity rights issues
• Note that the repayment of the borrowed funds to undertake infrastructure projects is not dependent on the success of the project. In general, lenders do not absorb any project risk.

Essentially the success of a particular project in part relies on the financial stability or predictability of the long term funding. As all the above forms of financing (except for equity rights issue) are dependent upon the bond market, as the bond market falls (yields rise), the projects undertaken in the future will need to generate a higher internal rate of return to be able to offset the higher cost of borrowing, the reverse applies also in the case of a rise in the bond market (yields fall), as projects become increasingly attractive.