Loyal to core investment strategies

Traditional core remains central to LP strategies, for now. But with risk appetite growing, the pursuit of higher-yielding investments is spiking interest in other approaches, writes Tom Higgins.

The resiliency of the infrastructure investment space has been severely tested over the past 18 months. The pandemic, subsequent lockdowns and changes in daily habits have resulted in rapid declines in stalwart elements of the market – including public transport, aviation and road infrastructure usage.

This is turn has resulted in typically stable revenue streams diminishing and raised questions about operating models within the space.

Simultaneously, the fractured global response, alongside the ebb and flow nature of the pandemic, has meant that infrastructure investors’ traditional playbook has been used in uncharted territory. Although it is hard to describe the global crisis as being ‘good’ for the sector, it appears that the storm has been weathered, with a variety of approaches helping investors navigate the turbulent times.

The resilience and subsequent rebound have been recognised by investors, which are returning their capital to infrastructure funds.

According to Infrastructure Investor fundraising data, more than $26.5 billion flowed into infrastructure funds globally during the first quarter of 2021.

The momentum was maintained into the second quarter – a period in which just over $30 billion was raised for the asset class. The second quarter saw a 60 percent rise in capital raised in comparison with the same period in 2020.

This indication of an economic recovery has boosted investor confidence and could give rise to new opportunities.

Strategy implementation

Historically, traditional strategies such as a core infrastructure investment approach have been relatively insulated from times of economic weakness and instability. Uncorrelated regulatory, operational and political risks have had a far greater effect on such strategies. As such – and notwithstanding regulatory shifts towards sustainability, the operational difficulties in global freight and supply chains caused by the pandemic, and the political uncertainties of Brexit – core strategies are still very much in focus.

“Investors are now becoming more risk-on for sectors that have been resilient and benefit from secular trends in the economy”

Declan O’Brien
UBS Asset Management

“In general, infrastructure investors continue to focus either on core-related mega-funds or potentially higher-yielding strategies,” says Peter Stonor, global head of transport, infrastructure and industrials at VTB Capital.

He adds that the combination of emerging opportunities related to the energy transition, digitisation, sustainable investment and emerging market themes are being used by investors alongside a more conservative core allocation. This affords investors both security and exposure to growth opportunities – the idea being that in a “continuing low-rate environment you can chase higher-yield strategies while being underpinned by core or super-core protection”, Stonor says.

A similar theme has been identified by Amanda Woods, chief investment officer at Amber Infrastructure, who also recognises that core and core-plus strategies are being increasingly centralised within an investor’s allocation.

“The recent compression in yields certainly indicates investors are currently, at the margin, less risk-averse than they have been in the past,” Woods says. “This is likely an evolution of mentality driven by the higher volume of opportunities available to investors over the past 18 months, where market turbulence elevated the narrative around risk and returns.”

Although core-related mega-funds are in vogue for some investors, Woods says that alternative opportunities within target geographies are gaining momentum.

“For investors with a higher risk appetite or more developed portfolios of infrastructure investments, strategies that allocate capital to differentiated geographies, such as the CEE, or those that push into newer, less invested and specialist types of infrastructure, such as energy efficiency and digital, are rapidly gaining a strong investor following,” she explains.
This duality – of reliable core infrastructure performance underpinning higher-yield, forward-looking opportunities – is grounded by the consistent performance of funds, thereby providing investors with a point to anchor upon.

Returns returning?

Stability within the low-yield segments of private markets provided a welcome source of returns for margin-starved investors, says Stoner. And by providing stable income, core infrastructure investments proved to be an “exception to the current volatility in public markets”.

“The listed infrastructure space is both early in its development as an asset class and
fast growing”

Alan Synnott
BlackRock Real Assets

The FTSE Developed Core Infrastructure Index benchmark made an annualised five-year return of 10.43 percent as of the end of March 2021, with a one-year return of 14.23 percent on the back of improved market stability and a lessening of covid-related restrictions.

A dominant trend seen throughout 2021 has been the variety of approaches used by infrastructure investors, Stonor observes – a response to the rapidly changing economic and risk-related environment.

“In 2021, there has actually been investment across all strategies, given the large limited partner allocations left over from 2020,” he explains.

“The market had been focused on the upturn in global GDP growth with the lifting of covid restrictions and reflationary policies [as well as] risk appetite returning to chase yields.”

At the start of the second half of last year, the tone shifted to concerns over “peak growth” and “peak liquidity”, Stonor continues. However, he expects that the forces driving higher-yielding strategies, accelerated by covid, will outweigh the macroeconomic concerns.

Declan O’Brien, head of infrastructure research and strategy at UBS Asset Management’s real estate and private markets arm, says that he has not witnessed a material change in overall risk appetites among institutional investors.

However, he adds that the catalysing impact of the pandemic on social and technological issues is driving enthusiasm among investors for more opportunistic trends within the market.

“Investors are now becoming more risk-on for sectors that have been resilient and benefit from secular trends in the economy,” he says.

Three Ds

O’Brien cites what he terms the “three Ds” – decarbonisation, digitisation and demographic change – as being “priority areas” for investors.

He believes such trends will continue to have an impact on the asset class in the decade ahead. A shift away from traditional, monopolistic assets is well under way, and investors are seeking to meet the demands of secular trends, spurred on by regulation.

Decarbonisation is a key example. Countries around the world are bringing in new environmental legislation affecting business and new-build assets in an effort to meet commitments to achieve net-zero carbon emissions in the decades ahead.

“The nature of these businesses often places them higher on the risk-return spectrum and, as such, the strategy an investor ultimately selects will need to match their tolerance for risk and yield,” O’Brien says.

Value-add strategies, for example, require ongoing investments over an extended period, with returns tending to be back-ended and “skewed towards capital growth rather than income”, he explains – an approach that may not suit more conservative, income-focused investors.

Listed infrastructure on the rise

Another key trend identified by experts has been the emergence of listed infrastructure investments as an asset class in their own right. The sector allows investors to gain exposure to rising themes such as decarbonisation and digitisation with greater liquidity.

“The listed infrastructure space is both early in its development as an asset class and fast growing,” says Alan Synnott, global head of research and product strategy at BlackRock Real Assets. “As with private solutions, listed infrastructure offers clients exposure to investment characteristics such as income and diversification, as well as the same themes that drive the rest of the asset class, such as decarbonisation, digitalisation and investing in demographic change.”

Shane Hurst, managing director and portfolio manager of the ClearBridge Global Infrastructure Income Fund, cites liquidity as a crucial aspect for many investors. His $57 million fund solely invests in listed infrastructure projects.

“We are right at the cusp of a very long-term secular growth story for infrastructure as an asset class,” he says, citing sovereign fiscal constraints that have shifted the burden of infrastructure spending to the private sector.

“This spending is under the domain of listed infrastructure companies, with capital deployed flowing into asset bases, which are regulated and earn a fair equity return.”

As the secular economy continues to influence the types of infrastructure being developed, opportunities within debt markets are also attractive to investors. “In recent years, we have seen the strong growth of infrastructure debt,” says Synnott.

It is a sector that continues to both grow and evolve, he explains, and is also on the cusp of a shift towards sustainability.

Since BlackRock first established an infrastructure debt franchise in 2013, Synnott has seen appetites and behaviours shift.

Although investors were originally attracted to investment-grade debt portfolios with long durations and high degrees of predictability, the buoyancy of the space has led to a shift in focus towards high-yielding debt opportunities, thereby shortening the duration of an investor’s involvement.

BlackRock recently closed a closed-end high-yield debt fund on $1.67 billion – three times its initial target – with notable interest from clients globally including insurers in the US and pensions in North Asia.

Synnott says there was a trend of clients re-allocating from the core equity space to this higher-yield offering, “given the relative value between both approaches”.

It would be a mistake to paint all investors with the same brush. However, it is clear that core investment strategies are still meeting certain requirements for investors, while debt is meeting their need for income in an increasingly low-yield environment.

As the shift to sustainability continues to gather momentum, and even greater flows of capital, investors will need to adapt.

At a time when collaboration between governments, infrastructure investors and the broader private sector is imperative to achieving sustainability goals, the approaches used today may not be the same as those used in the years ahead.