Siren song of Asia infrastructure lures funds

An investor looks at an electronic board showing stock information at a brokerage house in Taiyuan, Shanxi province, June 19, 2008.

HONG KONG (Reuters) - With trillions of dollars to be spent on infrastructure in China, India and other fast-growing emerging markets in coming years, private funds are pouring into a sector with clear opportunities -- and plenty of risk.

Asia is littered with infrastructure projects that failed during the financial crisis of a decade ago. Others lost money, were hit by corruption, or were unnecessary in the first place.

While backers say the increasing receptiveness of governments to private funding for big projects makes infrastructure more attractive nowadays, politics and bureaucracy as well as rising material and labor costs all threaten to crimp returns.

Investors big and small are flocking to the sector as Asia and other emerging markets rapidly urbanize, attracted by potentially steady long-term returns in real assets as a hedge against volatile financial markets.

The case for infrastructure spending is obvious: In India roads, power supplies and airports are notoriously inadequate after decades of under-investment. In Beijing, every day brings 1,200 new cars to the Chinese capital's gridlocked streets; large parts of China are girding for another summer of power shortages.

"For a fridge, you need reliable electricity generation. For cars you need roads," said Macquarie strategist Stewart Ferns. "Infrastructure investing is the best way to play the emerging markets scene at the moment in terms of the growth."

Last month, Morgan Stanley (MS.N) and a fund set up by General Electric (GE.N) and Credit Suisse (CSGN.VX) said they had raised nearly $10 billion collectively to invest in infrastructure projects around the world.

In Asia, private equity firms have raised $1.45 billion so far this year for dedicated regional infrastructure funds, according to the Asian Venture Capital Journal, approaching the $1.84 billion raised for all of 2007.

Societe Generale's (SOGN.PA) Lyxor Asset Management and Macquarie (MQG.AX) both launched infrastructure funds this year that are open to retail investors, while the fund arm of UBS (UBSN.VX) said infrastructure funds are a top priority in Asia.

"Governments are facing increasing budgetary constraints and many recognize that the private sector has a crucial role to play in the ownership and operations of infrastructure assets. The long-term opportunity is therefore enormous," said Christof Kutscher, head of Asia-Pacific at UBS Global Asset Management.

This month, Merrill Lynch lifted its forecast for emerging markets infrastructure investment to $2.25 trillion a year -- or 5 percent of gross domestic product -- over the next three years from $1.25 trillion. China, the Gulf and Russia are set to be the biggest spenders, with energy and transportation soaking up the bulk of funds, Merrill said in a report.

FORGETTING ENRON

Questions over land title, contract terms, and control can plague infrastructure projects, especially in emerging markets, giving advantage to local players with knowledge and connections.

So far this year, emerging markets transport infrastructure stocks have underperformed global equities, according to Reuters EcoWin. MSCI's index for the industry -- one of several sectors that falls under the broad infrastructure umbrella -- has fallen 26 percent over the past six months, compared with the 5 percent drop in MSCI's global stocks index

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(For a graphic on the performance of emerging market s transport infrastructure stocks, click here)

It has taken years for India to live down the legacy of Enron's $2.9 billion Dhabol power plant, which was built during the 1990s and mothballed for nearly five years over a billing dispute that was complicated by a change in state government.

"A less opaque regulatory environment would certainly help bring more investment," said Markus Rosgen, head of Asia Pacific equity strategy at Citigroup.

Infrastructure projects tend to be capital-intensive, long in duration and thus potentially exposed to economic cycles. A collapse in commodity prices would choke off spending in places such as Russia, the Gulf and Brazil.

"The biggest downside risk would have to be a macro kind of shock," said Rajiv Lall, chief executive officer of Infrastructure Development Finance Co (IDFC.BO), which last year unveiled a $5 billion Indian infrastructure fund with partners including Citigroup (C.N) and Blackstone Group (BX.N).

Too much money aimed at similar projects can raise prices and drive down returns, as has been seen in once-hot pockets of the property sector in China and India.

"Relative to building the 10th new retail mall in a suburb of Mumbai ... I'd much rather build the first distribution park in the steel industry of Orissa, where you've got great demand," said Alastair King, CEO of UK-based India investor Eredene Capital (ERE.L), which owns a warehousing operation near Delhi.

India says it needs $500 billion in infrastructure investment in the five years through 2012, with 30 percent of that expected from private sources, and is the target of numerous funds: Babcock & Brown BNB.AX, the UK's 3i (III.L), and a joint effort between the State Bank of India (SBI.BO) and Macquarie are among those raising or to have recently completed India funds.

"There are lots of opportunities, but for most of your opportunities, your IRR (internal rate of return) is very low because everyone is chasing that same opportunity," said Rosgen.

(Additional reporting by Jeffrey Hodgson; Editing by Anshuman Daga)