Soothsaying, unlike infrastructure investing, is typically a high-risk endeavour – and in this stormy weather, perhaps something of a fool’s errand.
Take the release of last week’s US inflation data. Yes, inflation cooled slightly to 6.4 percent in January (down 0.5 percent from December) but yes, you could also say it was higher than expected.
“Inflation may have peaked, but it’s not showing signs of rapidly returning to the Fed’s long-run goal of 2 percent,” said John Leer, chief economist with intelligence provider Morning Consult.
That means inflation might prove sticky, in the US and other markets, with interest rates remaining higher for longer. If that happens – and into the quicksand of predicting we now step – we are likely to see a tentative shift towards value-add strategies harden into a more permanent equilibrium. One spurred not just by our changed macro environment, but also by the two mega-trends driving growth across the asset class: the energy transition and digital infrastructure.
What’s going to make this shift to value-add 2.0 particularly interesting is that, for the first time in a decade, one of the premier levers for adding value – the big red one labelled ‘cheap money’ – is now out of commission.
First things first, though. According to our recently published LP Perspectives 2023 study, the value-add rebalancing is in full swing, with 82 percent of LPs surveyed planning to maintain or increase their exposure to such strategies this year, compared with 71 percent and 60 percent for core and super-core.
Gordon Bajnai, in charge of Campbell Lutyens’ infrastructure and energy transition activities, summed it up nicely:
“High interest rates will naturally lead to an increase in appetite for value-add strategies. There has been a significant flow of funds into core over the past four years, given the negative yielding fixed-income bond market. Now yield has returned to the fixed income market, which I think will reduce the previously excessive demand for core infrastructure, leading to a rebalancing with core-plus and value-add.”
Of course, no one is saying core strategies are finished. But “owning established core infrastructure and collecting yield, in the comfortable expectation the asset will sell for a higher price in five years’ time, will no longer be such a lucrative strategy,” Darryl Murphy, managing director, infrastructure, at Aviva Investors, wrote recently.
So, while the macro environment might have kick-started this realignment, we think it will be cemented by the requirements of investing in the aforementioned energy transition and digital infrastructure sectors.
We were reminded of that last week, when renewables outfit Eolian, a Global Infrastructure Partners portfolio company, closed a landmark financing for what it called the largest fully merchant standalone battery storage project in the world. As Eolian chief executive Aaron Zubaty noted, the project’s 100 percent merchant revenue profile “was intentional. Energy storage is not and should not be lumped with contracted renewables. The financing of energy storage assets must accept that it is a volatile business.”
We could make similar arguments for parts of the digital infrastructure market (hello, fibre), but the wider point is this: it’s hard to see, especially in a macro environment where LPs are demanding higher returns, how you can invest in the asset class’s twin-growth engines – which require the build-out of new, forward-looking infrastructure – without your value-add helmet firmly in place.
That, in turn, raises pertinent questions about the kind of skill set needed. For example, can generalists of a certain size continue to confidently assert their ability to add value to a plethora of sectors now that they can’t rely on the financial levers of yesteryear? Will specialist managers – or generalists with highly specialised benches – be the inevitable beneficiaries of this new trend?
It’s a brave new world out there – unless inflation quickly disappears and the money taps start flowing again.