Infrastructure is known for its resilience, and has even continued to perform against the backdrop of the pandemic. While other forms of investment have struggled, infrastructure has largely endured, increasing its appeal and attracting new players looking to ride the tailwinds. So what exactly does this mean?
Irene Mavroyannis, managing partner and global head of Private Capital Advisory, Infrastructure, Renewables and Sustainability at Sera Global, explains how the pandemic has been a factor. “It allowed infrastructure to demonstrate its resilience, as well as its other characteristics, which are very uncorrelated to other markets, particularly the equity market,” she says. “It’s defensive, has steady cash flows and isn’t volatile, so now you’re seeing a large number of investors either considering entering into infrastructure or reallocating funds from other portfolio allocations.”
As Jed Drake, research consultant, real assets at NEPC, observes, infrastructure was already gaining institutional favor, but the pandemic accelerated this trend. “With the obvious exception of transportation, particularly airports, the last year has shown the durable income profile that infrastructure can provide,” he says. “Institutional infrastructure strategies had been largely untested since the global financial crisis, and the recent stability has been the catalyst for increasing investor allocations to the space.”
The Other Factors
But is it only the pandemic driving investors toward infrastructure? Other factors are at play, namely the diversity offered by the sector and the need to move away from assets facing an uncertain future.
As Drake describes, “You have institutional investors seeking to increase their exposure to infrastructure, but you’re also seeing some groups moving away from fossil fuels. These investors may have ESG concerns or be unsure of the future demand for oil and gas, and they’ll move their allocations accordingly.”
Mavroyannis adds, “Infrastructure has increased recognition due to its characteristics, but investors have also noticed the growing opportunities within the asset class as a result of the pandemic, most notably digital infrastructure. It’s an essential service now, and we wouldn’t have survived economically or globally without fiber networks and communications towers.
“It’s the same with energy infrastructure, which is also gaining popularity. Within that you have renewables and electrification, but also the regulations set by various governments and their targets for decarbonization, which means a move into these areas, perhaps away from oil and gas, becomes a necessity.”
“Infrastructure has increased recognition due to its characteristics, but investors have also noticed the growing opportunities within the asset class as a result of the pandemic, most notably digital infrastructure.”
Minesh Mashru, head of infrastructure investing at Cambridge Associates, also makes the point that infrastructure will be a key recipient of the recovery funds set by certain governments as they navigate their way out of the pandemic. “If you look at the U.S. and Europe, infrastructure is taking precedence within those recovery budgets, and is seen as a way to stimulate growth, upgrading the fiber networks, and improving transportation and logistics,” he says. “That creates opportunity, especially with interest rates being low.”
For Gianluca Minella, head of infrastructure research at DWS Group, changes in strategy as a result of the pandemic have also led investors toward infrastructure. “They know that yields can only rise from here,” he says. “But there’s also a risk of inflation rising, so there might be a shift away from long-duration, fixed-income proxies, such as real estate. With something like data centers, for example, the potential for earnings growth will support the value of the asset in the long-term, as you’re not just offering the building, but providing additional services, from the operational platform to the team involved.”
Equity into debt is another area making an impact. “With the low-yield environment, there’s an understanding and appreciation by investors that both debt and equity provide much more defensiveness for a portfolio,” Mavroyannis adds. “We’re seeing equity investors pivot into debt, and debt pivot to equity, which offers greater choice for investors in addition to niche sector focuses.”
New Investors Revealed
So there is a growing interest in infrastructure investing, but who is it making the move? Allison Kingsley, founder and partner at NOVA Infrastructure, believes that existing players expanding their strategies, rather than launching entirely new funds, is where the majority of the activity lies.
“Several established managers have created first-time strategies or expanded into new parts of the infrastructure market as a new way to deploy capital,” she says.
Mavroyannis agrees. “You’re seeing an evolution of the investor base,” she says. “In the U.S., the new entrants are the pension funds, private and public, and infrastructure is a complementary investment in their portfolio. They have enough exposure to volatility and shorter-term high returns through their hedge funds, and with infrastructure being stable and defensive over the long term, it’s well suited for public pension plans.”
Mashru talks about the difference in the size of funds. “Infrastructure, by its nature, has a high barrier to entry in the underlying asset, because it’s very monopolistic, so you’re getting new entrants, but it’s hard for them to compete with some of the established players, particularly in the largecap space,” he says.
Kingsley has also noticed the consolidation at the larger end of the market. “Data suggests that the preference during the pandemic was to reu p with existing managers, with money flowing into already large funds, meaning that the average target deal size has gone up, even though larger deals are scarce,” she says. “This trend has increased the competition at the larger end of the market, in terms of size, and opened up the smaller end of the n1arket.”
Kingsley says Nova is seeing a migration of private equity into infrastructure, and real estate, a little bit. “Infrastructure is an attractive space, particularly but not exclusively because of its potential inflation protection,” she adds.
How It Changes the Market
A surge of new players in the market will ultimately have an effect. To begin with, does it mean more competition, or are there benefits? Mashru remains cautious. “You’re clearly getting strong managers coming in, but there’s always the risk of people who don’t have the expertise in terms of the technical aspect or the regulations,” he says. “It’s very important to do due diligence on the new entrants into the market, given the technicalities of the sector itself.”
But there are also signs of a move to counter this, with specialist funds being set up, as Mashru explains. “Telecoms
is a good example of an asset class that requires more operational expertise, with a lot of technological risk, so you create an investment that makes sense for a long-term holder of that asset, which could be a direct or strategic investor, or a listed, or all of the above,” he says.
A surge in the popularity of ESG funds has also led to a new approach, as Kingsley observes. “The new GPs that have come into the market recently are largely ESG funds,” she says. “Because some LPs are divesting from fossil fuels and investing those allocations in ESG, we’re seeing strategies trying to capture some of that increased demand.”
As Mavroyannis describes, “We’re seeing specialist funds coming into the market that are focused purely on renewables, or on digital or social infrastructure, and I think we’ll see more of those, complementary to the larger diversified funds.”
Minella adds, “The larger deals are scarce, so the smaller funds, the so-called mid-market, with thematic or value-added strategies, are a good way to counter this.
I also see an interesting development with funds incorporating ESG that offer a lower return, but promote a positive impact, and again that would be supportive of smaller niche strategies.”
New Blood, New Challenges
Infrastructure investment is gaining popularity, and overall this is seen as a positive development. “From the investor perspective, having more choice is always better than less,” Mavroyannis explains.
“But diligence is always critical in securing the expertise and creating an investment strategy with traction.”
For Minella, if that strategy includes ESG, then some extra care might be needed. “New entrants into the market might be able to provide an original ESG approach, and attract capital this way, but while it can be a positive game-changer, it’s important that investors go beyond the basic marketing elements, and really can demonstrate that they incorporate ESG factors.
“We’re seeing specialist funds coming into the market that are focused purely on renewables, or on digital or social infrastructure, and I think we’ll see more of those, complementary to the larger diversified funds.”
“Expertise will still matter, with the asset class not just giving exposure to new sectors, but allowing us to look at existing sectors in a different way. The managers most able to fundraise will be the ones incorporating ESG and with a positive track record. That won’t change for the broader allocations, but for the niche ones we’ll see investors looking for innovative strategies, particularly for ESG .”
And in terms of how the asset class may continue to attract new blood?
“There may be new sectors and assets that become opportunities, such as electric vehicle charging points, if the right business model becomes available, and we may also see growth in other areas,” Minella adds. “For example, new regulations in some countries allow retail capital to be invested in private assets, so that might be a trend.”
As NEPC’s Jed Drake concludes, “We expect the institutional infrastructure opportunity set to continue to evolve. It’s important to monitor the ongoing shifts and secular industry trends, as these will change over time.”
Reproduced with permission from Institutional Investing in Infrastructure (i3)