Co-head private infrastructure Americas, Partners Group
Senior partner, Actis
Head of brownfield, Infracapital
How do you see LP appetite for infrastructure risk and return evolving?
Mark Chladek: There is more demand for specialist areas within the asset class as LPs try to diversify their portfolios. This is evident through the continued segmentation of fund strategies between core, super-core, mid-market and so on. In the current environment there is likely to be a focus on funds where the manager is demonstrating inflation resilience, and we think that LPs will be attracted to opportunities where the manager is not just holding the core asset, but is actively looking to create value through growing or transforming businesses.
Torbjorn Caesar: One of the biggest trends in private markets today is the consolidation of LP capital. Investors such as sovereign wealth funds and pension funds have increasingly large allocations to private markets, and they can face challenges with deployment. As a result, they are looking to large funds to make commitments.
Investors today are also looking for yield; some estimate that we’re seeing $100 billion each month flowing towards private markets. Infrastructure is a natural home for this: it offers inflation-protected cashflows, and it is the closest replacement for fixed income and cash because it is long term and offers yield.
Todd Bright: We’ve seen our clients’ appetite for infrastructure grow during covid and believe that this trend will continue in the current environment. Infrastructure has proven to be stable and safe relative to other asset classes, with fundamentals for infrastructure having strengthened during the pandemic. We expect that this resilience, paired with the fact that infrastructure can offer an effective inflation hedge, will increasingly drive investors to reallocate to infrastructure from riskier asset classes, thereby favouring established GPs with good track records and teams that have invested through the cycles.
How will infrastructure strategies perform in this environment of high inflation and high interest rates?
TB: The most resilient strategies will be those that are prepared. Our approach of thematic investing in next-generation infrastructure and hands-on, platform-based value creation strategies is aimed at protecting returns against economic instability. We’ve been positioning our portfolio for rising rates by fixing debt and stretching out maturities, while underpinning revenues with long-term inflation-linked contracts. We have also been stress-testing our underwriting returns against the impact of higher inflation and higher rates and have been underwriting multiple compression at exit for years, leaving ample headroom relative to today’s (elevated) valuations.
TC: A whole generation of investors is having to cope with an inflationary climate they may never have witnessed in their lifetime. The risk is especially acute for those whose strategies depend to a significant degree on the kinds of fixed-income investments that have long been favoured by institutional investors such as pension funds. They have come to depend on the stable returns the asset class has offered. In an era of low inflation, this was rarely a real problem for them. However, with yields now significantly below inflation rates, investors have had to look even more closely at alternative assets to try to shield their portfolios from the worst of the headwinds.
MC: Infrastructure as an asset class is traditionally inflation-protected so it should be one of the safer places to invest in uncertain times. Typically, periods of high volatility drive demand for infrastructure investments. Inflation protection remains a key feature of our assets at Infracapital, whether that is through direct inflation-linked contracts or indirectly through high barriers to entry. True essential infrastructure should be able to pass on the higher cost of debt through the revenue line. However, we also mitigate interest rate risk through hedging.
In the face of mega-trends such as decarbonisation and digitalisation, which strategies will find themselves on the right side of disruption?
MC: We are certainly of the view that those sectors that will find themselves on the right side of disruption are in the new infrastructure space and not the old. Fibre has emerged as the newest utility, and the covid-19 pandemic heightened its importance for obvious reasons. We were early identifiers of this trend, first investing in Gigaclear in 2015 and now growing eight fibre platforms across seven countries. The decarbonisation of the transport sector is another one to watch, and we recently invested in leading businesses such as Recharge, an EV charging operator in the Nordics, and BCTN/MCS, a sustainable inland container terminal operator in the Benelux.
TB: These are exactly the ‘giga themes’ that Partners Group focuses on, in addition to new living. Our approach is to develop deep expertise in themes that focus on above-average growth segments that benefit from transformative trends. Within these themes, we identify ‘mega themes’ with strong infrastructure characteristics – within decarbonisation, for example, it is about building the next generation of low-carbon infrastructure through clean power, low-carbon fuels and carbon management. Sustainability factors also shape our investment approach and underpin our thematic focus areas.
TC: We see complementarity between areas such as power, infrastructure and real estate. If we look at power, electricity is growing at a pace that is well above GDP. Even without taking into account electrification trends, such as the move to electric vehicles, growing global demand doubles the need to build power plants.
On top of that, the world needs to decarbonise, so there is an enormous need to invest here. Investment in electricity is already at the highest levels in history, and that now needs to accelerate – and fairly rapidly.
Which of the emerging or niche infrastructure strategies is set for the most growth in the coming years?
TC: The huge latent appetite for digital infrastructure assets. We are living at a time of surging internet demand, while covid-19 has only accelerated the shift to a more digitised world. Yet there is a significant supply and demand mismatch, which the increase in data consumption and streaming services, the use of the cloud and the adoption of 5G technology will only reinforce. Many of these assets have a number of significant characteristics that may make them suitable as an inflation hedge.
MC: Recent events in Ukraine have reminded policymakers of the importance of energy security, so clean energy and energy-transition-related assets have massive potential for growth. Within this, storage will be a large part of the solution and more entrepreneurial companies – such as our thermal battery company, EnergyNest – will come to the fore. More generally, we are seeing some niche opportunities in the telecoms/connectivity space and, longer term, hydrogen is emerging as a feasible gas replacement.
TB: We don’t focus on niche strategies. Rather, our thematic approach allows us to identify high-conviction themes and provides flexibility from a risk-return perspective. We have a global platform with 20 offices, enabling us to stay close to the themes we want to invest in and be nimble when we see shifts in relative value. Some of the emerging themes that we are reviewing include industrial decarbonisation, ‘circular economy’ including waste-to-value and other re-use applications, and ‘new mobility’ including smart cities or roads and fleet and connectivity.
What’s the biggest change you can see on the horizon with regards to infrastructure fund formats?
MC: I think it will be related to sustainability and tighter regulation around that. We are increasingly seeing investors apportion capital to ‘impact’ or ‘net zero’ allocations, and the introduction of SFDR classifications will likely see a drive towards Article 8 funds.
TC: Thematic investing – investing behind the big global themes rather than an industry vertical, technology or geography. We also see a mutual benefit to longer-term consolidated strategic partnerships between LPs and managers who can offer them scale, a range of global products and measurable positive impact.
TB: Our clients are often looking to find more efficient ways to invest on behalf of their beneficiaries. We address this by offering bespoke client solutions as an alternative or complement to traditional closed-end funds. These can include customised mandates, ie separately managed accounts catering to specific objectives and requirements of a single investor. Both structures offer flexibility, allowing clients to capitalise on active portfolio management and capture additional performance.