A few days before sitting down to write this, the Bank of England raised interest rates by the highest amount in 27 years to combat rising inflation. The greater concern, however, was the stark warning that the UK’s economy “is now projected to enter recession from the fourth quarter of this year”. With other major economies also hiking rates and potentially facing a downturn, the post-covid recovery is well and truly over.
The infrastructure industry had expected these rate jumps for some time now, and managers have positioned themselves accordingly. Investors are largely confident that the asset class can ride the storm better than others, owing to infrastructure’s inherent inflation-hedging fundamentals. But there could still be an impact on investment activities.
Fundraising data from Infrastructure Investor clearly shows that investors are still hungry for infrastructure. The $112.7 billion raised in H1 2022 represents some 75 percent of the fundraising figure for the whole of 2021.
In such a turbulent period, it is no surprise that ‘safe-haven’ core infrastructure continues to attract the majority of commitments from LPs. At $29.9 billion, capital raised for core funds in H1 2022 alone has eclipsed the 2021 full-year total.
But the data also suggests that macro pressures are already starting to change the direction of LP capital. Opportunistic funds, for instance, raised $18.4 billion in the first half of the year – their highest annual total, before the year is even out. In the value-add sphere, funds in market are targeting just over $30 billion, with Antin Infrastructure Partners V – the second-largest infrastructure fund on the road as of July – seeking $12 billion.
The proven downside protection and long investment horizons on offer with core investments are understandably appealing in this climate. But diversification is – and probably always will be – the single most important tenet in any investment strategy. So, where does this leave the rest of the infrastructure spectrum?
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Diversify, diversify, diversify
With diversification as much about risk as it is return, a well-constructed portfolio really comes into its own in volatile macro environments. “Investors benefit from a variety of exposures to different asset classes and a variety of macro and micro exposures in order to reduce risk,” says Jamie Storrow, managing director and head of infrastructure at Northleaf. “In the context of infrastructure, that means accessing a good mix of asset types to ensure you have inflation protection, economic benefits and defensive characteristics in a variety of scenarios.”
With that in mind, it stands to reason that we can expect strategies at both ends of the risk spectrum to remain attractive to investors, and not just core. Indeed, in our LP Perspectives 2022 Study from the beginning of the year, only 3 percent of investor respondents were looking to invest less capital in value-add strategies in 2022, the smallest proportion of all strategies. Forty-nine percent said they would invest more in value-add funds.
For Mounir Corm, founding partner and deputy chief executive of Vauban Infrastructure Partners, core and value-add are not strictly competing for capital. Instead, appetite for both strategies will grow, reflecting investors’ overlapping objectives. “Both will continue to be in demand as LPs that are already invested with core managers look for additional returns in the value-add space, and as others that are under-allocated to the asset class – or else started out in value-add – increase their core exposure,” he explains.
Even within core strategies, there is plenty of diversification at play. “As a core manager, we look at PPPs and regulated utilities, but we also look at long-term private offtake contracts with solid counterparties and concession schemes,” says Corm. “That diversity of revenue stream is extremely important.”
That specialist touch
Diversifying risk-return can take many forms, but there’s one particular approach that is gathering significant momentum in the infrastructure market: specialisation. Last year, funds investing in only one sector of infrastructure raised 39 percent of total asset class capital. This is the highest figure in a decade.
One could easily argue that the increase in sector specialists operating in the infrastructure asset class is a natural consequence of the market’s growth and maturity. Just like the stratification we have seen with the advent of core-plus and, more recently, ‘super-core’ strategies, a market naturally separates into more refined brackets to meet the increasingly nuanced needs of its increasingly sophisticated architects. But somewhat paradoxically, investing significant sums in specialist funds is also now a recognised strategic diversification play.
In June this year, Brookfield closed a $15 billion opportunistic fund dedicated to the decarbonisation of brownfield energy infrastructure assets, smashing its initial hard cap by $2.5 billion. Further, last year DigitalBridge raised $8.3 billion exclusively for investment in digital communications infrastructure in what was the largest sector-specific fundraise of 2021.
The ability to leverage specialist market knowledge is a key attraction for LPs. This is particularly pertinent in a heavily technical and innovative sector like renewables and, of course, digital infrastructure, where individual subsectors require deep expertise to operate effectively. “Many of the sub-segments of digital infrastructure – like DAS, small cells, colocation data centres, WiFi and enterprise fibre – cannot be managed passively,” says DigitalBridge’s chief commercial and strategy officer, Kevin Smithen.
With Brookfield’s Global Transition Fund not alone in its endeavours, the energy transition looks to be offering some of the best opportunities for specialism due to the wide range of assets on offer, each with their own risk and return characteristics. “You have solar and wind, and increasingly battery storage and green hydrogen are on the horizon,” explains Paul Buckley, FIRSTavenue chief executive and managing partner. “Further, there is waste-to-energy. So, the sector is beginning to exhibit a lot of those diversification characteristics.”
Specialising therefore does not mean narrowing one’s range of exposures. “Diversification is what investors look for in a specialist sector, and that is where they are putting their money,” adds Buckley.
Helped along by covid travel restrictions, the increasing regional specialisation that we have seen over the past couple of years could also leave a mark on the industry. Of the infrastructure funds closed in 2021, three-quarters target a single region – the largest proportion since 2018. Data for the first half of 2022 shows that trend continuing.
As specialist managers and product launches turn more heads, it would be natural to question the future of the generalist fund in all this. Remembering the lesson of diversification 101, however, suggests that the healthiest market offers something for every investor, and for every corner of their portfolio.
“Sustainable investments will always be the most resilient investments”
While many in the industry may be split on the value of core versus a higher-risk bet at this point in time, there is one key tenet that is common among investors’ return goals in this turbulent macroeconomic period. Investing in the sustainability mega-trend is now an undisputed strategy for resilience.
Indeed, a growing number of funds – Brookfield’s behemoth among them – have made this their raison d’être, focusing solely on decarbonising carbon-intensive industries such as steel, cement, transport and feedstock. Since climate change cares not for economic conditions, many investors are hedging their bets on protecting the future of the planet as a sure-fire path to value creation. What’s more, decarbonising existing brownfield assets would likely cost less than building new renewables projects from the ground up – a key consideration when inflation is high.
A sustainability-focused strategy could prove especially critical in Europe, where energy security is under serious threat from Russia’s efforts to limit the supply of fossil fuels to the continent. In March, the International Energy Agency released its 10-Point Plan to reduce the EU’s reliance on Russian natural gas. Accelerating energy efficiency improvements in buildings and industry, diversifying and decarbonising sources of power system flexibility, and accelerating the deployment of wind and solar projects were all named as measures that could be taken this year to help “bring down gas imports from Russia by over one-third”.
More generally, funds focused on building ‘next-generation’ infrastructure – assets that are less carbon intensive and more energy efficient – should appeal not just to investors searching for higher risk-adjusted returns than they may be getting from core or other equity investments, but also to those looking to safeguard their portfolios through a choppy market. “Sustainable investments will always be the most resilient investments,” claims Amanda Woods, chief investment officer at Amber Infrastructure.
Last but not least
Underpinned by a focus on sustainability and other mega-themes influencing the direction of LP capital, namely digitalisation and changing demographics, strategies such as debt and secondaries offer alternative avenues for portfolio protection.
Fundraising data from Infrastructure Investor shows that $5.4 billion was raised for infrastructure secondaries funds in the first half of the year, the vast majority of which was secured by Ardian’s ASF VIII Infrastructure – the largest such fund ever raised. Although real assets secondaries are still a small part of the overall picture, representing only 11 percent of total transactions last year according to Greenhill, activity is still increasing. Infrastructure secondaries are enjoying a honeymoon period of activity following the record $14.5 billion raised in pandemic-stricken 2020.
Fundraising for infrastructure debt, on the other hand, has continued to wither since the record set in 2019. That said, the market is sitting on substantial dry powder and had a potential $30 billion in the fundraising pipeline as of July, which was only around $100 million less than value-add funds.
As the probability of recession in global economies increases, Alexander Waller, Patrizia’s head of infrastructure debt, is confident the strategy can deliver for investors throughout the economic cycle. “Our borrowers have long-duration cashflows and long-term borrowing available to them. That is particularly important as we enter a challenging period caused by inflation and rising interest rates,” he explains. Investors that secured long-term debt while rates were low “can benefit via increasing rates that feed into their floating rate returns, even as other asset classes perform poorly”.
Nervous times lie ahead, but the infrastructure market should cope better than many. Backing the right strategy – or indeed strategies – will be paramount.