One of the leading European global asset managers told me once that “infrastructure would never fly”. Well, in a way that was right, given that most infrastructure assets are grounded, but the past decade has demonstrated how irrelevant that statement was.
I have spent the past 20 years contributing to the development of the infrastructure asset class as an advisor, lender and fund manager. That’s probably an unconscious consequence of my education as a mechanical engineer, but it also comes down to personal inclination and passion – what did you expect when my first experience was to fly in a helicopter 50 metres above the Persian Gulf sea to visit the main platform of an oil field extension programme?
On the eve of starting a new professional challenge, I thought it might be useful to look back over the past 10 years at the infrastructure market and imagine what challenges are to come.
A defining decade: from a niche play to an asset class
Quoting Sir Paul McCartney, it is fair to say it has been a long and winding road to establish infrastructure as a true asset class and an investment strategy as such. There is no doubt the low-interest-rate, low-inflation and low-growth environment following the global financial crisis helped infrastructure to become what it is today: a preferred alternative strategy for institutional investors looking to deploy capital into yielding strategies, uncorrelated and inflation-linked to their asset and liability management responsibilities as a collateral. Just don’t call infrastructure a bond-like strategy. Because these are mostly demanding industrial businesses and infrastructure remains a complex, structured investment for specialists.
It took a lot of back and forth – sometimes harsh, sometimes funny, always relevant – to arrive at a dedicated infrastructure allocation for investors and its related risk-return expectation (e.g. from fixed income to a private equity sub-category), fund manager remuneration and the difficult question of alignment of interests in the context of presumably longer-duration products.
There was also much discussion around the attractiveness of doing direct investments for the right reasons – and not just to save on fees – as well as how to deal with the massive inflow of capital into a buoyant market, despite a relatively stable pipeline of opportunities. All of this accompanied by changes to investors’ strategies, implementation plans and regulation. Still, the infrastructure asset class has performed.
Despite all that, it feels like the industry continues to strive to find optimal ways to channel private money into infrastructure and design appropriate investment structures that address the long-term nature of the asset class, which I believe is crucial to enable truly sustainable investments.
The private equity fund model, from which infrastructure initially took inspiration, is not ideal because it is designed to be short term – whereas infrastructure is, by essence, long term.
This contradiction makes it sometimes difficult to ensure a proper balance between investment profitability, its duration and the duties and obligations imposed by the license to operate infrastructure assets. The driving force shall always be to ultimately work in the best interest of the end-user.
For instance, spending unnecessary capex to artificially increase regulated revenues or generate private equity-like returns based on a potential growth story is not sustainable in the long term. What’s more, there’s not always a growth story for infrastructure assets. The recent tightening of regulation in certain sectors to rebalance outperformance sharing further echoes this.
People and resources may be another area of development. Financial and industrial expertise is required to properly run an infrastructure investment programme. From my experience, infrastructure investments – even if they are often contracted or highly regulated – are far from passive and require high maintenance. I am still amazed to see that many institutional investors with direct investment strategies are under-resourced, even for minority stakes.
Finally, we have also witnessed a broadening of the infrastructure definition, with new sub-sectors considered for investment. This was primarily driven by a desire to move away from the more competitive core/core-plus strategies and competition from players with a low cost of capital.
However, because infrastructure had to first establish itself as a true asset class and agree to standardise its offer under pressure from powerful market forces and players – such as asset consultants, who always prefer to box-in a product – it has become a little too static and forgotten to be creative, innovative and more importantly, to embrace the new world.
A new industrial revolution
In May 2007, the European parliament voted to back an official declaration committing to a new industrial revolution with an economic and sustainable development plan which would lead Europe to a post-carbon era. This industrial revolution, which many opinion leaders are calling for, is supported by the new convergence of digital communication technology and new energy production based on renewable sources.
This revolution has been rendered necessary because fossil fuels and other essential constituents on which most of our activity and infrastructure primarily rely upon, are depleting fast and alternatives must be implemented. This couples with a global awareness that climate change is real, despite what President Donald Trump might say, and mitigating it needs to be our top priority.
This third industrial revolution has and will radically change all aspects of our society, including the way we work and live together. The vertical backbone of our society – which is typical of the economic, social and political life of prior fossil-fuel based industrial revolutions – is slowly giving way to more distributed and co-operative relationships and organisations. We are moving away from a centralised, very hierarchical model to a distributed, connected and autonomous model that scales laterally.
A good illustration of this is the current ongoing transformation of our electricity grids to adjust to multiple distributed renewable-based production units, which are slowly evolving into smart independent regional grids. This new lateral energy regime lays down the organisational model for many economical activities which will arise from it.
This new organisational style stems from peer-to-peer interactions and open-source networks. A few examples of these changes, which are already affecting us, include the use of blockchain technology or connected and autonomous car solutions where access rights and sharing capabilities override the sacrosanct ownership principle.
The infrastructure market will not escape this major evolution. We must transition quickly to an ‘Infrastructure 3.0’ regime, in which institutional investors represent the main source of capital to support it. And we need to restore meaning to the European infrastructure-investment landscape, which inevitably calls for a few changes. They include:
- Infrastructure investors who primarily manage the money of infrastructure end-users, directly or indirectly, must further assume their social responsibilities. These go beyond existing ESG factors and policies and call for investors to apply impact-investing and financing criteria in their investment processes to support this transition towards a post-carbon era;
- A redefinition of infrastructure to adjust to a fast-changing industrial environment and to become a proactive player of the third industrial revolution. Infrastructure as an investment strategy should address new sub-sectors – including electricity storage solutions, data centres, cross-country/continent interconnectors for energy, transport and data, smart mobility and sustainable communication networks;
- The improvement of fund models to better match the underlying long-term nature of infrastructure investments – including greenfield – which probably requires a rethink on liquidity options and managers’ remuneration;
- Finally, a change in return expectations more in line with our current macro environment and a new era in which financial and social capital reach a balance.
The world is changing and the infrastructure real assets must cope with it. Let’s get started.
Philippe Taillardat was until recently one of the three co-heads of Infrastructure Investment Management, Europe at First State Investments. He has more than 20 years’ experience in principal investing, financial advisory, equity and debt financing across various industrial sectors including energy and infrastructure.