Historically low base rates, moderate growth and low inflation at best have been dominating the macroeconomic picture in many developed markets in recent years. In this environment, appetite for infrastructure assets has been rising continuously as investors increasingly value the asset class for its stable cashflows and inherent protection against future inflation. This has attracted capital to the sector and, in combination with the high availability of debt financing, has allowed asset valuations to surge.
Core brownfield assets in developed jurisdictions are particularly sought-after as they are widely perceived to be the most stable. Given the attractive characteristics of these investments, they have become the most mainstream among investors drawn to the infrastructure asset class. However, with modest underwritten equity returns for these assets only in the mid-single digits, Partners Group maintains its belief that investors are not always adequately compensated for inherent business, regulatory or macro risks, and that there is a clear chance some of these assets might underperform when regulations change or when real rates start reverting back to long-run levels.
Against this backdrop, we think it is especially important for investors to remain disciplined on new investments. Below, we give a quick summary of the outlook in different regions and markets and outline some areas of relative attractiveness globally in the current market environment.
In Europe, high levels of investor appetite for infrastructure assets from both Europe-based and international investors continue to lead to record-high valuations in the core brownfield segment. In a competitive environment like this, we believe it is important to focus on finding attractive opportunities outside the crowded core space.
Assets attracting less mainstream attention can be found in the communications and renewable energy sectors, including greenfield broadband, capitalising on the need for new investment to address low penetration rates across much of Europe and high demand supported by policy initiatives. Greenfield renewable opportunities in select segments, such as offshore wind or biomass, also offer attractive risk-return profiles, particularly in jurisdictions where the probability of adverse changes to tariff support is perceived to be low, such as the UK, Germany or France.
A number of attractive opportunities are also arising out of a new wave of corporate sales of energy infrastructure from oil and gas majors and utilities. The significant drop in commodity prices, combined with high levels of physical supply, is forcing these corporations to review their business plans and capital allocations, while at the same time limiting their access to the capital markets. This creates opportunities to purchase assets no longer deemed core in the mainstream space that are underpinned by positive market characteristics.
In North America, there are attractive opportunities in the communications, power, and energy infrastructure sectors outside the mainstream investor focus.
In communications, as in Europe, the broadband investment sector is attractive, given the fact that strong growth in broadband demand and policy support are creating tailwinds at a time when carriers are shifting from infrastructure ownership to capacity/spectrum purchases. Furthermore, the disruptions in commodity markets are affecting the North American energy infrastructure landscape, driven by the massive shift in the supply of natural gas from shale and resulting drop in prices, which is accelerating the replacement of coal-fired energy production with natural gas.
The US Energy Information Administration predicts around 60 gigawatts of cumulative coal retirements by 2020 across the United States, requiring significant replacement capacity even without demand growth. The substantial ramp up in gas production, coupled with the shift in gas-fired power, underpins the need for gas infrastructure, both within the US and across the borders in neighbouring countries.
At the same time, environmental initiatives and more stringent environmental regulations have created incentives for producers to build out renewable generation capacity. The growing utilisation of renewables to support electricity demand is changing the requirements of the electrical grid. Renewable resources are less predictable in nature and their intermittent generation characteristics mean that electricity supply can go through several sharp changes throughout the day, increasing grid reliability risks. As a result, the requirement for flexible generation capacities to ensure grid reliability is growing and places a premium on assets that can ramp up flexibly and start and stop multiple times per day.
This creates strong, non-mainstream investment opportunities in these sectors in the US, however, the overall attractiveness can vary significantly. Partners Group has chosen to focus its efforts on greenfield power assets with long-term off-take agreements, for example new-build onshore wind farms, and “value-add” brownfield power assets.
EMERGING ASIA AND LATIN AMERICA
Emerging Latin American and Asian markets continue to provide an attractive case for investment in infrastructure, driven by economic growth and continued high demand for private capital to fund infrastructure investment.
However, investable opportunities remain scarce, not least due to intensified currency volatility and continued uncertainty around regulatory risk in many countries. With mainstream infrastructure investors focused primarily on Europe, the US and Australia, emerging markets can offer superior risk-adjusted returns and should be considered as part of a global infrastructure portfolio. We see opportunities surrounding the build-out of energy, transportation and communication systems, in particular with ‘out of market’ opportunities that offer solid fundamentals and protect investors from downside risks such as currency risk.
Across emerging markets, regulatory changes in support of renewable energy could provide significant investment opportunities in the months and years to come. Subsidy regimes are being boosted by fundamental demand drivers and many governments are placing increased emphasis on decreasing their dependence on fossil fuels.
An example is India, where government support for renewable energy has dramatically increased following the 2014 elections. The new government has initiated a number of positive policy changes to stimulate investment in infrastructure and particularly renewable power infrastructure. In addition, a growing economy and low per capita power consumption compared to neighbouring countries imply an inherent power deficit that bodes well for future demand.
Competition is also increasing in the market for infrastructure secondaries, with ever more participants entering the space, willing to pay high prices. The focus of most market participants remains on acquiring established brand-name infrastructure funds, where bidders are now seeking prices from a single-digit discount to a small premium.
This environment is testing investment discipline and, as such, we think investors should be cautious on mature assets, especially in Europe, where high valuations imply low returns going forward. Inflection assets are more attractive, especially in North America, where funds can benefit from dislocation in the energy space. Furthermore, we see an opportunity to take advantage of non-traditional situations, such as portfolio restructurings.
An increasing number of managers are considering term extensions of their more difficult vintage funds, such as 2007-vintage funds, in order to gain more time to sell off their remaining portfolio assets. These so-called tail-end liquidity solutions represent a growing segment of the market and are an attractive investment opportunity for flexible and experienced investors, as the long-term nature of many of these offerings limits their suitability for smaller and less experienced infrastructure secondaries investors.