What are invitations and how do they work? – Forbes Advisor INDIA
Simply put, an infrastructure investment trust is a common investment vehicle like a mutual fund. While mutual funds invest the amount received in financial securities, an InvIT invests the same in real infrastructure assets such as roads, power plants, transmission lines, pipelines, etc.
Here’s what you need to know about InvITs and how they work.
How InvITs Work
InvIT is a commercial trust (like REIT), registered with the market regulator, which owns, operates and manages operational infrastructure assets. These long-term income-generating infrastructures in turn generate cash flows, which are then distributed periodically to unitholders.
InvITs are a hybrid of equity and debt investing, that is, they exhibit both equity and debt characteristics. While the operating business model helps provide stable, predictable, and relatively risk-free cash flow like debt, there is potential for growth like equity because returns are not set with scope for change. of the unit price.
- InvITs are designed to mitigate the risks of under-construction in the infrastructure sector, as at least 80% of the investment must be made in completed and income-generating projects.
- The instrument aims to ensure stable and predictable cash flow, as 90% of distributable net cash flow is distributed to investors.
- These assets have long-term contracts that provide stable cash flow over the long term, typically 15 to 20 years, depending on the underlying assets.
- They provide an opportunity for growth by adding more mining projects and increasing yield.
- Public InvIT units can be listed and traded on a stock exchange (with a minimum subscription / purchase value of INR 1 lakh), like shares, thus offering the possibility of trading these units without any blocking.
InvITs help infrastructure developers free up capital by monetizing completed assets. The infrastructure developer can transfer part of its income-generating assets to an InvIT, which can then issue units to its holders. Thus, InvITs stimulate the creation of infrastructure, providing an effective means of raising capital from investors – individual and institutional and financing the development of new projects.
On the other hand, InvITs offer individual investors the opportunity to invest in a long-term performance instrument in the infrastructure sector and help to establish higher standards of governance in the sector.
From a stakeholder perspective, the InvITs proposal for involved stakeholders includes:
- Developers: Monetize operational assets to free up capital and develop new assets.
- Lenders: Diversify exposure to better quality infrastructure assets with higher ratings.
- Investors: Obtain stable and predictable returns from a portfolio of operational assets.
- Government: Monetization to create space for further infrastructure development.
Benefits of investing in InvITs
Anyone investing in the capital markets looking for a combination of stable distributions and growth can invest in InvITs. InvITs offer advantages such as:
- Predictable and stable cash inflows – The Securities and Exchange Board of India (SEBI) market regulator requires InvITs to distribute a minimum of 90% of their cash income to investors on a semi-annual basis, making them ideal for long-term investors looking for cash flow regular.
- Low risk: In accordance with SEBI regulations, InvITs must invest at least 80% of their assets in completed and income-generating projects. InvITs cannot invest more than 10% of their assets in projects under construction. This reduces the risk for investors as it reduces the greatest risk associated with the infrastructure sector i.e. delay in completion, due to lack of regulatory approvals, financial close, etc.
Leverage limits for InvITs are also regulated and defined by SEBI, thus protecting the company from the risk of over-indebtedness.
- High quality assets: InvITs house long-term infrastructure assets with superior credit quality and low demand and price risks, i.e., insured annuity cash flows (pre-regulated cash flows every year) such as electricity transmission, renewables, telecommunications towers, roads and gas distribution. These assets generally have a lifespan of 15 to 20 years with reliable counterparties providing clear visibility into returns.
- Liquidity: Exiting InvITs is similar to selling equity investments, making them very liquid and easy to sell without any lock-in period compared to closed-end mutual funds or other asset classes to fixed maturity or illiquid trade.
- Robust corporate governance: Regulatory requirements such as the management of InvITs by independent trustees and investment managers, as well as other measures such as semi-annual assessment by independent assessors, minority investor rights, mandatory rating requirements, Strict disclosure policies and tighter caps on leverage, all constitute strong corporate governance in InvITs.
In addition, the board of directors of the investment manager must be composed of at least 50% of independent directors.
- Portfolio diversification: Portfolio diversification is a crucial aspect for all categories of investors. Especially in a market like this, diversification is not only important from a risk perspective but also from a return perspective. In the current scenario where interest rates for secure investments like term deposits are low, investors are looking to explore alternative investment options for better returns and capital appreciation without assuming high risk.
- Risk-adjusted returns: As there is visibility into the cash flows of the underlying assets held, InvITs can be tailored to hedge one’s portfolio against market volatility. This is also underlined by the beta (risk premium) of InvIT which is much lower than that of other equity products. So, when calculating the returns of InvITs, one should also look at risk-adjusted returns (not just absolute returns), as InvITs tend to generate better returns for lower risk.
- Efficient tax structure: InvITs benefit from a concessional long-term capital gains tax rate (such as equity) if the units are held for more than three years and sold on the stock exchange.
Risks of investing in InvITs
Investors should be aware of the risks below when investing in InvITs:
- Operational risks: These include risks due to force majeure events that affect the availability of the underlying infrastructure projects and have a negative impact on revenues. Other operational risks may also include collection delays, one-time expenses, volume or traffic risk, and pricing risk.
Operational risk can be mitigated through reliable payment security mechanisms and insurance coverage, etc. Investors should look for stable underlying assets with good quality management teams to get around these risks.
- Refinancing risk: Infrastructure projects are mainly financed by debt. This contemplates large ultimately repayments and fluctuating interest rates, which can pose a refinancing risk. Investors should be careful not to opt for long-term AAA rated infrastructure assets with higher credit quality and low demand and price risks.
- Regulatory risk: Infrastructure is a highly regulated industry in India. As the InvITs are in their infancy, regulations are still evolving.
- Risk of return: Since public InvITs are traded on an exchange, unit prices can fluctuate, resulting in capital gains or losses, as in the case of stocks. Also, it is important to note that the cash flow of the trust depends on the underlying business. Thus, depending on the underlying activity and assumptions, the income of the underlying asset and therefore of the trust may be variable in certain years.