Infra becomes a port in a storm for investors

Appetite for infrastructure soars as inflationary concerns dominate.

Almost two-thirds of investors in infrastructure funds plan to increase their allocations to the asset class over the next 12 months, a greater proportion than for any other private markets asset class, reveals Infrastructure Investor’s LP Perspectives 2022 Study. Meanwhile, 30 percent plan to retain their current level of exposure, leaving just 3 percent looking to cut back.

This is unsurprising. The proportion of total assets under management being allocated to alternatives is only moving in one direction. Over the next five years, investors anticipate increasing the share of their overall portfolio that goes to alternatives by 6.9 percent on average.

Meanwhile, 59 percent of investors currently describe themselves as underallocated to infrastructure. They are playing catch-up. Again, the trend is more pronounced than in private equity, private real estate, venture capital or private debt.

Performance has also been strong – 86 percent of LPs say their infrastructure portfolios have met or exceeded benchmarks. And confidence remains high, with 27 percent of investors anticipating that their infrastructure portfolios will exceed performance expectations in the next 12 months. This represents a slight increase on the 23 percent that demonstrated similar optimism a year ago.

“Obviously, yield is a major part of infrastructure’s attraction, at a time when institutions are struggling to find that yield elsewhere,” says Brent Burnett, co-head of real assets at Hamilton Lane. “That balance between current income and capital appreciation is something this asset class has demonstrated strongly over the years, so where investors are looking for yield, but also the opportunity for growth, that is taking them straight to infrastructure.”

A potentially volatile macro environment, amid ongoing concerns around covid, is also playing in infrastructure’s favour. “The pandemic has reinforced the attractiveness of this asset class,” says Bruce Chapman, founder of Threadmark. “From a risk mitigation perspective, investing behind hard assets feels a lot safer than investing behind services companies, as you would do in private equity. Governments are also upgrading infrastructure in order to support a post-covid recovery.”

In addition to the impact of covid, extreme valuations, recession in core markets and the threat of higher inflation are creating increased demand for the uncorrelated, non-cyclical returns infrastructure promises. Although only 6 percent of investors across all private markets anticipated that inflation would significantly impact investment performance a year ago, inflation is seen as a major concern for 40 percent of private markets investors today.

The protection afforded to infrastructure assets through natural monopolies or inflation pass-throughs in tariff negotiations with regulators or CPI-linked revenues is therefore a major appeal. “I do think that inflation is on people’s minds,” says Bart Molloy, partner at Monument Group. “I would expect inflation-hedged real asset strategies to benefit from those concerns.”

“Infrastructure is positively correlated to inflation because of CPI escalator clauses in contracts, as well as the intensity of capex required to develop infrastructure, which means replacement cost tends to go up over time as materials get more expensive,” says Burnett.

Of course, infrastructure is not immune to the macro environment. Investors cited regulation, political instability and frothiness in the market as particularly concerning. And although many assets are hedged against inflation, 27 percent of investors in infrastructure funds cited any associated increase in interest rates as their primary concern when it comes to performance, compared with 10 percent a year ago.

It all depends on why rates are being raised, however. “If rates are going up in an expansionary economic environment, that tends to be positive for infrastructure,” says Burnett. “The question is whether infrastructure will be negatively impacted if rates are going up purely to contain inflation.”

The popularity of digital infrastructure and renewables continues to soar, with 64 percent of investors planning to increase their allocation to both sectors. “Digital infrastructure is probably the fastest-growing segment of infrastructure spending,” says Gordon Bajnai, head of global infrastructure at Campbell Lutyens. “The need for investment in digital infrastructure is almost unlimited in both emerging and developed markets.”

“There are some really strong tailwinds behind some of the sectors that infrastructure targets, most notably renewable energy, and the digital space,” says Burnett. “In addition to yield, inflation and total return, there is a strong macro case to be made for infrastructure today, and institutional investors are recognising that.”

Telecoms was third on the list, followed by social infrastructure. And more than a quarter of investors even plan to increase their allocation to the beleaguered transport sector, in anticipation of a post-covid bounce back.

As ESG becomes an ever more important factor in investor decision making, environmentally unfriendly sectors – and energy in particular – are falling out of favour, with 31 percent planning to reduce exposure.

In terms of risk stratification, core-plus and value-add strategies are attracting the most attention, with 83 percent and 80 percent of LPs respectively planning to invest the same or more over the next 12 months. “Appetite is strongest in that core-plus and value-add space,” says Burnett. “We don’t see a lot of interest in the opportunistic space and there are relatively few players at the core end of the spectrum. The bulk of institutional appetite falls in between.”

Yet Bajnai believes core infrastructure is set for a comeback. “Historically, around 70 to 80 percent of all fundraising has been targeted at value-add strategies. However, as more and more money moves into the asset class in search of yield, I think that proportion will wane. Large LPs are seeking to replace negative-yielding fixed-income instruments with an asset class that offers similar risk profiles and duration, but also yield. They get that with core infrastructure.

“To give you some context, pre-covid, the value of negative-yielding investment-grade assets in the world was around $6 trillion to $7 trillion. Today that figure has risen to $16 trillion. If you are an asset allocator at a big pension fund or insurance company, core infrastructure is the natural solution to that problem. We have already started to see increased interest in core over the past few years and I fully expect that to continue.”