InvITs: The next big infra story

India needs a whopping ₹100 lakh crore over the next five years for infrastructure fit out that can lift its growth to the next level, the Union Budget for this fiscal has noted.

That’s an order of demand beyond the wherewithal of traditional modes of financing, and will clearly need a more concerted effort involving innovative modes.

Enter infrastructure investment trusts (InvITs), a kind of intermediate between debt and equity, which may be just the sort of innovation India needs.

Though a relatively new asset class in the country, InvITs have been quite popular globally for a while now, given the all-round benefits they offer.

What are InvITs?

An InvIT is an investment vehicle created to hold income-generating and operational infrastructure assets such as roads, power transmission lines, gas pipelines, etc.

These assets have long-term contracts with strong counterparties that provide a steady cash flow over the long term – typically 15-20 years.

In a way, InvITs are like mutual funds – only, instead of owning financial securities, InvITs own and manage real infrastructure assets.

Units of InvITs can be listed and traded on a stock exchange, providing them liquidity. Or they can be private and unlisted, in which case they are not publicly traded and largely invested in by institutional investors.

The key parties involved in an InvIT are sponsors (issuers), trustee, unitholders, investment manager (who takes all the acquisition/ divestment related decisions) and project manager (who is in charge of running the various project special purpose vehicles). This structure, mandated by the regulator, attempts to minimise the risk to investors and enable better corporate governance.

A win-win for investors and developers alike

For sponsors (infrastructure developers), InvITs provide a convenient route to monetize revenue-generating assets, unlock equity gains, and deleverage their balance sheets. Most importantly, these allow the developers to invest in new projects while maintaining their capital structure.

InvITs also present a more tax-friendly structure. Being a trust, all income received by the InvIT from underlying assets receives a pass-through treatment and is not taxable at the InvIT level.

For investors such as banks, financial institutions, pension funds, insurance companies, and even retail investors, InvITs provide a good low-risk investment opportunity.

The regulation for InvITs requires them to have at least 80% of their investment in operational assets and also to ensure that at least 90% of the free cash flows are distributed to the investors. These two clauses ensure InvITs have very limited construction risk related to infrastructure assets and also that cash flows generated are used primarily for distribution to unitholders, thereby providing steady returns.

Thus, these are high dividend-paying investments, suitable for both institutional and retail investors seeking stable, long-term cash flow with moderate capital appreciation. It’s a nascent market, but the potential is enormous. Currently, there are five operational InvITs in India with a combined AUM of around ₹60,000 crores.

CRISIL believes this can increase manifold over the next 2 years, driven by the need of infrastructure developers to monetize their mature assets and also due to strong appetite of global investors looking to invest in India’s infrastructure growth story.

These InvITs have investments in power transmission, roads and gas pipeline sectors. Some have plans to invest even in relatively newer sectors such as telecom infrastructure – towers and fibre, and renewable energy. Long-term offtake contracts and strong counterparties provide revenue visibility, making these sectors attractive to investors.

Other infrastructure assets having similar characteristics, such as ports, hospitals and airports, may also witness investments through InvITs going forward.

The amendment by the Securities and Exchange Board of India to reduce the minimum subscription amount for a publicly listed InvIT to ₹1 lakh from ₹10 lakh is a good augury for expanding the investor base. With the limit lowered, more retail investors can now invest in InvITs.

Some risks need watching, though

The key risk in an InvIT would be the operating risk of the underlying assets. For instance, for a road assets-based InvIT, the key risk would be the growth of traffic, and for an availability-based power transmission asset, the key risk would be the strength of the counterparty and the payment security mechanism.

Another major risk would be the capability of the sponsor to grow the InvIT by adding more and more operating assets in a cost-efficient manner.

The perceived quality of corporate governance of the investment manager also plays a critical role in financing and valuations and hence is a potential key risk to watch out for.

To sum up

Overall, the market for InvITs is still evolving and is relatively nascent in India, with only a handful of InvITs registered till date. However, with the government impetus to the development of the infrastructure sector and an expected higher economic growth over the long term, InvITs can emerge as an attractive investment enabler for the infrastructure sector. These can act as an efficient investment vehicle to enable long-term funds for infrastructure creation, from both retail investors and global institutional funds.

Also, banks typically fund under-construction infrastructure projects. If, upon completion, these assets are transferred to an InvIT, it can free up banking capital to be re-deployed to other projects, thus promoting a virtuous cycle of funding infrastructure development.

Given India’s gargantuan infrastructure financing need, therefore, it is given that more and more InvITs will be launched in the next 2-3 years.

(Sachin Gupta is Senior Director at CRISIL Ratings. The author is speaking at a webinar series titled ' Future of Infrastructure Investments' here.)