What are InvITs? Are we ready for it? Experts discuss

Thus the InvIT helps an infra company sell-off a part of its completed projects to new investors and secure funds for new projects. In a way, InvITs replace banks as funders for infra projects.

InvITs are like real estate investment trusts (REITs) - in that the REITs are backed by rent-generating real estate assets and InvITs by cash generating infra projects like roads or power grids or even power projects.

However, InvITs are different because the returns depend on both growth and on inflation.

Besides the sponsor and the trust, the InvIT has a project manager who manages the under construction projects and operates the completed assets. The InvIT also has an investment manager who makes investment decisions related to the InvIT and oversees the project manager.

To get more answers on this complex new product, CNBC-TV18 spoke to Neeraj Gambhir, MD & Head-Fixed Income, Nomura, Shankar Raman, Director - Finance, L&T and Shilpa Kumar, Managing Director and CEO, ICICI Securities.

Below is the transcript of the discussion.

Q: This product is complex, so are investors educated enough? Do you expect it to start finding buyers anytime soon?

Kumar: I will say certainly. People absolutely understand the product, but there are lots of little nuances to any new product that especially institutional investors would like to understand. And I will say there is a very good reason for spending some time, understanding this product because we are at a time when debt yields are not that high and at a time when equity valuations are looking rich.

So, especially if you are looking for something long-term with a pretty decent return and the possibility of some upside, then Infrastructure Investment Trusts (InvITs) look interesting. So, there is a good incentive for people to actually spend some time and understand this product and I find there is a lot of institutional investors who have spent the time, understood it and I might say seem to also like what they are seeing.

Q: Are there enough disclosures? Infrastructure is a very complex area. Are all the rules adequate? Do they reassure the investor enough, the buyer?

Gambhir: Like it happens with any other product, things tend to evolve over a period of time based on the experience gained. Right now, it seems like we have a fairly comprehensive set of rules and regulations including the ones for disclosure, including the ones for the investors. But as the market will evolve, some of these rules and regulations may change, but it feels like we have a fairly reasonable and comprehensive regulatory framework for this product to take off. Where the market is currently that there is a lot of investor education going on, given the nature of the product, each InvIT will be different because the underlying asset is going to be different, the underlying cash flows are going to be different.

So, the investors will actually have to deep-dive quite a lot to understand the assets, the cash flows, the operating environment and then based on that, they will take a call. So, while it is going to be a listed, traded product, it is also going to be something which will involve a lot of investor education not just at the product level itself, but also per transaction. Each transaction will be a different transaction.

Q: That is why I began with disclosures because if you are going to put a set of infrastructure projects and sell them as a mutual fund unit then do we know enough about what will be their projected revenues, what has been the historical revenues? What is your sense? How much disclosure? In the first place, will every bridge and every road that is put in that InvIT have even stable revenues?

Raman: In so far as disclosure is concerned, the stress has always been on past track, how the asset has played out, how the cash flows have been. I do not think even SEBI does encourage futuristic projections in their disclosures because of the underlying uncertainty. Neeraj said it right. While the product is interesting, the understanding of the product at ground level is a big task. It cannot be translated into paragraphs of English because A] we are dealing with several economic variables when it comes to revenues of public assets like toll roads for example.

My own sense is that where inflation will go, where interest rate will go, where the political calls for the tolls to be collected or not collected will go. There are several imponderables when it comes to projecting over a 20 year or a 30-year timeframe. So, there is an element of risk that is involved in these future projections and that precisely causes a current challenge for InvIT. It is a very interesting product, a product that actually is required for the market, but to be able to cash on it, it is very important that there is some revenue certainty that comes into the product. Today, the variability is pretty high and that makes the investor, while interested in the space, a bit hesitant to commit his capital.

Q: Before I come to the worries or investor concerns, even the how to of the product, I am not very clear. In a Real Estate Investment Trust (REIT), you will have both rental earnings as well as the terminal value of the land. But, in an infrastructure product, in a build, operate, transfer (BOT) model, the unit itself goes away to the government. So, you only have 20-year revenues. So, therefore, it works like a fixed maturity plan (FMP)? I mean does it have a time-bound existence?

Kumar: Annuity is always the word which better captures it. So it is an annuity which in fact you are going to get over a period of time. And like we discussed, the point was made that not all revenues are fixed. Some of them are variable. The variability can come out of things like where does inflation go, the variability can come out of things like how does toll revenue pick up or not and these are discussions which indeed you end up having with investors.

The advantage of pricing any new product with institutional investors is that the right questions get asked, the right questions get answered and in spite, the price discovery then is much better because you have people on both sides of the table with pretty good understanding of what questions also need to be asked. So, I agree with the other panellists that indeed, in each case, there will be particular nuances of that specific asset. So, all of these discussions need to be had and in a sense, some assumptions have to be made.

Q: For instance, let us assume there is a set of road projects of a company that have been put in an InvIT. What will the yield offer be? Will it be 200 basis points over government securities (G-sec) or will it be more like an equity because it is going to generate probably 8 percent gross domestic product (GDP) growth and therefore, 8 percent traffic growth? How will you price it, as a debt or an equity?

Kumar: I agree that is always the big question and I would say it is not one size fits all. There will be some InvITs where the assets are much more fixed annuity based. That will be more debt like. There will be some annuities where actually there is a bigger element of a variable return. Those would tend to be a in a sense more hybrid with a little bit of fixed return, but also a lot or some element of variable and the investor is precisely making up his mind basis, all of this.

Therefore, you might see that some InvITs give you a higher return. Just for the sake of argument - road InvITs might give you a higher return than let us say, transmission assets because transmission is more fixed while on the roadside, there is a bit of a variability. So, it is really to do with what is the project you are looking at.

Q: Therefore, should we assume that we will not get stable reveues? What should the investor be prepared for? Will he definitely get at least above G-sec revenues? Is that a given?

Gambhir: Certainly. I think you are taking a project risk especially if the underlying is roads, you are taking quite a bit of project risk. Therefore, the investor expectations of returns are going to be considerably higher in my opinion. There will be certainly some variability depending upon the composition of the underlying assets. What is the composition of annuity versus toll? If it is entirely annuity then certainly there is a lot more stability, but if there is a combination of toll versus an annuity then there is a lot more variability.

So, like it was said before, you need to look at the composition of the underlying assets, what is the stability of cash flows of those assets and apply some kind of risk assessment, some kind of stress analysis and then come up with a certain amount of return that you need to have to justify investing in that project.

Now to some extent, people are used to doing all this. When banks, for example, take credit risk on a road project, they do that analysis, they do that variability analysis to see what kind of volatility can be there in terms of underlying cash flows. So, again, you cannot put a number, you cannot say 200 basis points over G-secs is sufficient. The project composition will decide what is the desired return. If it is a very high variability then maybe the returns need to go up to double digits to justify taking risk in that assets.

Q: But this will be more like closed ended unlike REIT which may continue for a longer period and investment trust can last only as long as the concession period for that project lasts. So, does it work like a fixed maturity or a longer term, a closed ended fund kind of product?

Gambhir: You do have investment trusts where the trust manager has the ability to take on new assets as and when they become available. So, again the design of the investment trust is very important. If it is a design in which you are saying that just a fixed number of projects and that is it, those will work like a close ended or rather a defined maturity.

So, if you have trusts where you have the optionality available to the investment manager where he can actually take on fresh assets, it could be a little bit more like long dated, open ended investment trusts. But design is very important in that sense.

Q: In that case is there any quality control because if it is privately placed investment trust, I can imagine that there will be 20 people who will be able to take a call on whether he is bringing quality trusts, but when it is a hundred investors in an InvIT, how will you take permission? How will a sponsor take permission?

Kumar: InvITs have taken some time to get going and partly, that is because the regulators spent a lot of time thinking through all these future potential issues. And this whole move towards majority of minority, those kind of governance structures are really intended to kind of keep good governance in trusts like this and to make sure that the voice of investors is heard and it is not like they are passive investors and really the operator can do whatever he wants. So, regulation has kind of looked at all of these future eventualities, put some thinking into the governance process.

Q: So, there will be a voting?

Kumar: Yes, correct. So at the trust level, the investors will have a right to take a view on whatever is going to happen.

Q: So, if one concession ends and another new road is getting added then it happens through vote?

Kumar: Yes, that is correct.

Q: Look at the state of infrastructure companies today. Many of them have not been able to service their debt with the kind of money that they are getting and returns on their capital is fairly far out for a large part of the infrastructure projects that are currently in operation. Will that not be a risk? Is there a meeting ground at all between what the infrastructure builder wants in terms of returns and what investors will be able to pay?

Raman: In our conversations with investors, what becomes clear is that they are not only looking for return on investment, they are also looking for return of investment. So the approach that they take is let us take, a project takes about three years for the construction to get completed and the project gets commissioned and let us take another three years for the traffic to stabilise for people to have some visibility of what the cash flows would be.

That virtually, in today's era, leaves a period of about 15 years for the investors to take a call on the project. Within this 15 years, he needs to get return on investment as well as return off investments. So, he is possibly looking at maybe about 10-12 percent of cash yield which represents both the principle return and the interest return. Now, the investors who are more energetic and more enthused about these projects today unfortunately happens to be international investors and they have to take care of the currency aspect as well.

So, considering all of this, we find that for this product to fly, it is very important that the underlying cash flows are made attractive. And this is where this government needs to come in. It is not so much of a financial confession, they have to address the point that the investors who are private are beginning to hold public assets. When private capital owns public assets, there is lot more responsibility than just concessions being given.

Now let me take a case in point. You touched on this demonetisation aspect. We do understand the importance of this measure and are supportive of it. But at the same time, the economic consequences of these measures need to be fully understood. If collectively all the toll road companies have lost about Rs 1,500-1,800 crore during the period of one month holiday that they tool, the understanding was that cash will be replaced by whatever benefit that would come from the government. Debts have to be serviced. The toll operations have to go on.

So, there are cash obligations available. When cash flow stops and that is not replaced by like to like cash flows, then there is considerable damage that gets done to that debt servicing capability of the toll operator. Today, the government is thinking about extending concessions to be able to compensate. Now cash losses cannot be compensated by back ended concession extensions. These are very fundamental economic principles which actually enthuses an investor to look at these assets with a lot of interest and predictability.

Today the bane seems to be that these assets are viewed as higher risk than what they intrinsically are. And the policy makers and the operators need to make sure that the risks are minimised and well-articulated. We are some distance away from doing this and which is why I feel while the regulators are ready, the bankers are ready, the product is possibly ready, the investors are still shy and they are looking over the fence to see how they can get predictability to the revenue flows.

Q: I agree with you on the political risk. Sometimes market disciplines actors and it is possible that when there are a dozen investment trusts, the government also will realise that it cannot play fast and loose with returns. But I still want to come back to whether there is a meeting place for sponsors and investors right now, today, when infrastructure has borrowed so heavily and growth has come short?

Gambhir: That is where the track record of the projects will be very important. The corporate governance standard of the sponsor is extremely important. The overall corporate governance that they have displayed in the entire suite of investments that they have made is going to be extremely important. So, while we look at the cash flows, we look at the variability of cash flows, the underlying projects, the economic aspects of it, these are all important things that will go into it.

Equally important will be the softer aspects like what is the corporate governance arrangement that is there with respect to the investment manager, what are the historical track record around managing these issues. So, that is extremely important from investor standpoint. In the beginning I would say that you would see more success around fairly well established sponsors who have a track record in these asset classes. Those are the kind of players who will be able to attract quality investors, those are the guys who will be able to get the InvITs priced tightly. That is something which we will likely see probably.

Q: What are likely to be the initial returns? Will InvITs be priced around 10 percent?

Kumar: I will say around 10 percent is a good way to put it because like I said earlier, if there are assets which are more fixed annuity in nature, you might see even a little bit below that. But if there are assets which are a little bit more variable and there is a possibility of upside, you might see something above that. And everything we discussed on the show, all of that goes into determining exactly where around that number.

Q: But considering that airports have been stalled or become more expensive that they were originally intended, ditto with roads, are there investor sponsors to bite at 10 percent? Will they want more?

Kumar: It is all a question of what is the annuity looking like, what is the variability implied in those cash flows and what is the sponsor's intent. So, if actually you are a sponsor who can free up capital and actually go out and invest in more assets then you might be willing to, in the interest of getting the market started, you might be willing to leave something for the investors. And that is always how the process works.