Just as the Covid-19 crisis started to fade, more trouble appeared on the horizon to dominate the economic environment. At one end of the scale, the eruption of the war in Ukraine and at the other, rocketing inflation and interest rates.
Some asset classes have struggled amid the storms of the 2020s. But, according to Preqin’s 2023 global report on infrastructure, investors “flocked” to unlisted infrastructure in 2022 “amid rising inflation, a global energy crisis and intensifying pressure to accelerate the energy transition”.
The data provider also forecast that it would be the second-fastest growing private asset class on the basis of asset under management. Its end of year report anticipated a 13.3% compound annual growth rate (CAGR) up to 2027, behind venture capital at 19.1% CAGR over the same period.
Infrastructure, which emerged as an asset class more than a decade ago, has evolved in that time. Described by McKinsey as “traditionally staid and stable,” the consultancy says it has been shaken up “by revolutions in energy, mobility and digitisation”, with next-generation assets emerging, such as battery storage, smart motorways and data centres.
There have been some bumps in the road, though. Preqin’s Q1 2023 infrastructure report acknowledged a “difficult start to 2023” due to a slower pace than anticipated with $3.1bn (£2.4bn) raised by 11 funds. This is only 9% of the quarterly average of the past five years.
But the report also said that “the asset class is on the right trajectory, longer term”.
Survey results, published in July, by real-asset investment manager Patrizia have affirmed the enduring attraction of infrastructure. The firm’s third annual survey of its international institutional client base found that more than half (60%) of the 122 respondents are planning to expand their allocation to such assets during the next five years.
It also showed that 11% of these investors are planning to do so by more than 10% − a drop from last year’s 20%, which Patrizia attributes to “the more tentative outlook on the current market environment”.
Commenting on the infrastructure trends revealed in the survey, Graham Matthews, the firm’s chief executive of infrastructure, said: “Investors understand that the global megatrends of decarbonisation, digitalisation, urbanisation and demographic change make the long-term picture for infrastructure highly attractive.”
Its reputation for stability is another reason why investors expect to increase their allocations, as Darryl Murphy, Aviva Investors’ managing director of infrastructure, says: “Investors recognise that infrastructure provides long-term, stable cash-flows with good linkage to inflation.
“It has proved itself resilient to economic downturns, as witnessed during Covid and through other recent macro-economic challenges,” he adds. “It also exhibits strong ESG characteristics, which an increasing number of institutional investors want to see reflected in their exposure to the sector.”
Marija Simpraga, infrastructure strategist at Legal & General Investment Management Real Assets (LGIM), also points to the attractions of resilience and stability. “As infrastructure has emerged as an investible asset class over the last 10 to 15 years, a big part of the story has been about access to stable and robust income.”
She also highlights how institutional investors are increasingly aware of the opportunity in infrastructure – in debt and equity.
“To gain exposure to resilient cashflows underpinned by robust fundamentals and strong ESG credentials,” Simpraga says. And Jerome Neyroud, head of infrastructure debt at Schroders, anticipates that infrastructure will stay steady. “In our view, valuations are likely to go down in private equity. But we expect real estate and infrastructure to remain more stable and hence we will see a flight to quality from investors.”
Strong and stable
As well as revealing plans to increase allocations, Patrizia’s survey discovered that almost half of investors expect a pickup in infrastructure transactions and opportunities during the next 12 months. Also, around a third of investors expect recurring income to improve this year, and more than half (55%) anticipate recurring income from infrastructure to be stable.
Tom Maher, Patrizia’s managing director of infrastructure, said: “Despite the economic uncertainty, the essential nature of infrastructure, combined with the tailwinds provided by the global megatrends, continue to drive demand and revenue for infrastructure.”
Looking at listed infrastructure, as well as at infrastructure generally, Nick Langley, a portfolio manager at Clearbridge Investments, points to the themes and trends that could produce an ongoing source of income and capital growth.
“Given the multi-decade themes of decarbonisation, greener transport and 5G rollout, more infrastructure assets will be created in the coming years, which will generate greater cashflows and support attractive investor returns, including income and capital growth.”
Daniel McCormack, head of research at Macquarie Asset Management, believes that the drivers of income growth will vary this year.
“For some assets, the link between inflation and cashflows will drive income,” he adds. “For others, it is the exposure to structural demand trends of digitalisation, energy transition and demographics. While for some, company-specific business plans are driving the expansion in income.”
Themes, trends and opportunities
Reflecting on areas of infrastructure that investors are considering, other than traditional assets such as roads, bridges and airports, Murphy says: “The energy transition requires significant investment over the next few decades and that will continue to provide the principal opportunity for infrastructure investors.”
It is not the only growth theme in the sector. “Over the past few years, the other major growth sector has been digital infrastructure, namely towers, fibre and data centres,” Murphy says. “This sector will continue to grow globally, although investors are increasingly cautious around the issues of scale and competition in local markets.”
McCormack takes a similar view. “Demand for greater data connectivity has been growing rapidly, subsequently driving a demand for the infrastructure to facilitate that growth – such as data centres and fibre networks. We expect this to continue to grow rapidly in the future, particularly given the number of data-intensive technologies emerging, including driverless cars, the Internet of Things and AI, among others.”
But there is still room for the traditional, core infrastructure assets, along with the more contemporary ones. “Traditional assets such as electricity and gas distribution networks remain a key part of any infrastructure portfolio. And as our energy system changes and evolves there may be an increased need for both of these types of assets,” McCormack adds.
Patrizia’s survey results echoes the focus on these trends, finding that institutional investors are largely focused on decarbonisation during the next five years and that more than a third (35%) plan to increase their exposure to telecommunication infrastructure and fibre.
As with all investments, there are risks, and in infrastructure there are themes and trends to be bypassed, says Dan Ryan, a portfolio manager at Fidelity International. “Themes and trends we’re looking to avoid would be so-called ‘next generation’ infrastructure assets that appear to be stable, secure and anti-inflationary, like traditional infrastructure assets, but actually hide secret correlations to commodities, economic growth or evolving regulation and technology risk. Some areas of energy transition, transport and digital infrastructure can show this trend.”
Why so low?
Research published in June by capital advisory firm Hodes Weill and Cornell University’s Program in Infrastructure Policy, also concluded that institutions are “poised to continue allocating a significant amount of capital to new infrastructure investments”.
The survey, which sought the views of 63 institutional investors across 16 countries, revealed that 60% of respondents are under allocated to infrastructure.
The report said that sentiment towards private infrastructure remains relatively strong, but on average, global institutions are under-allocated to the asset class by 98 basis points relative to their targets, supporting expectations of increased capital flows into the sector.
Mark Rudovic, principal and head of real assets at Hodes Weill, said: “Despite systematic risk in the form of the denominator effect plaguing private market allocations during the last 12 months or so, sentiment towards infrastructure amongst allocators remains positive given the resiliency of performance through a rising interest-rate environment, heightened geopolitical tensions, high inflation and global supply-chain challenges impacting all verticals of infrastructure.”
Inflation will, inevitably, be a big factor. “Infrastructure remains a particularly favoured asset class for institutional investors, and the inflationary risks affecting other asset classes will drive capital to infrastructure as a safe haven, as asset owners are often able to pass through rising costs, demonstrating resilience in the face of a slowing economy,” Rudovic says.
Commenting on why there is a lack of exposure to the asset class, Andrew Cox, co-head of infrastructure at Allianz Capital Partners, said: “The reasons will vary between investors. However, infrastructure is a relatively low-return asset class, historically seen as secondary to private equity, which has higher but more volatile returns, but has also benefited significantly from the lower interest-rate environment since the global financial crisis.”
Cox does expect this under-allocation to rebalance somewhat in the current geopolitical and macro environment, as “investors look for more stable and predictable returns”.
Assessing how investors are navigating geopolitical and macro-economic headwinds for the asset class, Simpraga says: “When it comes to investors committing new capital to the sector, while a lot of macro-economic uncertainty persists, institutional investors are focusing more and more on the ‘super core’ assets which benefit from traditional infrastructure core qualities, such as high barriers to entry, quality and cashflows visible for the long term. These types of assets will tend to have more inflation protection built into the revenues, while their valuations may be less affected as more investors seek out quality assets.
“This trade-o between cashflows and valuation is something investors will need to continue to work through until the uncertainty in the macro-economic environment clears,” Simpraga adds.
There are other challenges and risks afoot, despite an upbeat outlook for infrastructure, McCormack says. “Given its defensive nature, healthy yield and inflation hedge characteristics, we believe infrastructure is well placed to deliver relatively good returns in the current environment.”
That said, McCormack sees the outlook for GDP growth as concerning, which could be challenging for some infrastructure assets at the higher end of the risk spectrum. “Interest rates have also risen sharply over the last two years and the full impact of that may be yet to fully play out, although this has implications for all asset classes,” he adds.
And investors will need to remain alert, to make the most of the opportunities, Murphy says. “The ability to parse longer-term thematic trends will be increasingly important, to capture outperformance. Infrastructure investors will need to be able to identify key economic, political and technological developments in order to identify the right assets. The risk profile of different types of infrastructure is likely to change as these trends play out, necessitating continual reassessment to keep portfolios future proofed.”
Murphy also observes how rising rates, technological innovation and climate change will mean the next 20 years of infra- structure investment will look very different from the last 20. “But one thing is certain: investors will have to leave their comfort zones if they are to grasp the risks and seize the opportunities,” he says.
Will investors embrace these opportunities to build infrastructure into their portfolios?