‘It doesn’t feel like the right time to be taking a great bet on a V-shaped recovery’

This is an edited extract of a conversation between Simon Davy, head of private markets at the UK’s Local Pensions Partnership, and senior reporter Zak Bentley at Infrastructure Investor’s Global Offsite in July. Full coverage of the event can be found here, here and here.

How is infrastructure performing?

SD: We’ll begin to see some marks coming through the portfolio, but it may be towards the end of this year that we’ll see something more material. We’ve had a relatively small exposure across LPPI’s infrastructure allocation to airports and toll roads. We do have some exposure to ports and rolling stock. We’re seeing companies being a bit more defensive on yield and preserving cash. The valuations have held up reasonably well compared with the volatility in the public markets.

How will this crisis affect core-plus and demand-based assets?

SD: We’re using our private equity portfolio to generate the higher returns and higher risk, but I certainly see an approach to portfolio construction that has some mix of value-add and core within it. In relation to some of the transport assets and some of the core-plus assets, it’s going to be a case of a willing buyer and a willing seller.

The tricky area for investors such as ourselves is how much recovery do you factor in and over what timeframe, particularly when it’s affecting near-term cashflows. The risk is you make certain assumptions that prove to be wrong or we go into another lockdown or the recovery doesn’t come through. And then early in the investment cycle, you’ve been proven to have an overly optimistic outlook and you’re taking a writedown on your valuations.

We’re representing perhaps slightly more cautious pension schemes in terms of our investment outlook. It doesn’t feel like the right time to be heroic and taking a bet on a V-shaped recovery. But for some people out there, it may be a good time to get into some of these transport assets at a good price.

How are you doing things differently now?

We’re just going to choose our asset classes within infrastructure and the opportunities on quite a careful basis 
Simon Davy

SD: We came into this crisis with what seems to be a very full set of valuations on infrastructure assets. We’re on the back of a 10-year bull market for infrastructure.

If you have a balanced portfolio, then it’s certainly felt like we had a market out there where valuations were very full. We’ve now suffered a downturn and that’s going to make investors such as ourselves think more carefully about the downside scenarios. At the same time, we’ve got unprecedented levels of borrowing by the government and interest rates lower than ever.

One of the things we’ve seen emerge over the last few years is the ever-broadening definition of infrastructure. Some people consider that to be a negative thing, but it does allow investors to choose the risk profile within their portfolios. If you take a long enough investment horizon – we have a 15- to 20-year outlook – we’re positive on the sector. There are perhaps some better short-run alternatives in private credit where we can earn better returns, but those give us an outsized return over the next one to three years and we’re looking to deploy over a longer duration.

What were you doing in March to secure your portfolio and what are you doing now?

SD: The solid performance that we’ve seen from our infrastructure portfolio has been because we had a lower weighting towards some of the highest-exposed infrastructure assets. In March, there was a highly intense period of asset management and considering the cashflow impacts across a number of assets.

We hit the pause button on any new investments. That said, there were a couple of processes we were looking at that continued. There was lots of scrutiny on management teams and funds and reporting on the impacts of the coronavirus. We progressed over the months coming into June and we’re now definitely seeing signs of life on the direct side, and we’re seeing many more processes starting to be launched. Compared with Q2 2019, there’s less than 50 percent – maybe around 25 percent – of the activity levels. I definitely see a real pick-up. We’re probably going to see Q4 becoming really quite busy as people have stored up these processes.

How did you know it was time to lift the pause button?

SD: It was a pause to assess what the impact would be across the asset class and across sub-sectors – and, in part, because it was hard for sellers to continue with processes. As we come out, our focus will be more on core assets – probably where there’s less of a judgment around GDP and the rate of recovery. That said, there’s been an impact on power curves and energy prices, so you’re having to form a view around some of those factors. The level of policy stimulus and policy response probably gives us some confidence there’s going to be a supportive environment for infrastructure investment. It may be that infrastructure is a core plank to that policy response. That may result in co-investment opportunities, which means you should have a slightly more positive outlook.

How will your strategy during the rest of 2020 be different to what it would be normally?

SD: There will be some more volatility. However, you are able to borrow, funding costs are not bad compared with pre-covid levels, and capital is available. There’s been a recovery in broader asset prices. We’re going to see more uncertainty in the public markets. I think we’re going to choose our asset classes within infrastructure and the opportunities quite carefully. I see a number of areas of opportunity within that. There seems to be a growing pipeline of offshore wind and renewable energy to invest in.

There are some reasonably defensive assets across Europe that will hit our radar screen. We are still looking for a balanced portfolio and for global exposure, so we will look to make some fund investments as well. Fund commitments perhaps will recover a little bit slower, but I still see a huge volume of capital approaching infrastructure.

Will infra live up to the stable asset class it is sold as?

SD: The main consideration is portfolio construction. If you’ve got a balanced portfolio across a mix of sub-sectors, then we’re going to see infra doing what it’s expected to.