History shows that when volume develops in any market sector, stratification comes next. “In infrastructure, the private equity and real estate markets provide a future roadmap for the industry,” says Paul Buckley, chief executive and managing partner at placement agent FIRSTavenue. In addition to generalist core, core-plus, value-add and opportunistic strategies, we are witnessing increased specialisation by sector, geography and size.

Meanwhile, the infrastructure secondaries industry is also rapidly maturing, with $5.4 billion raised by funds closed in H1 2022 alone. Buckley believes the secondary market is poised to see growth in both LP- and GP-led transactions.

Gordon Bajnai, head of global infrastructure at private capital advisory firm Campbell Lutyens, meanwhile, expects to see the amalgamation of primary fundraising and secondaries within single financial products. “I think that is going to be an important trend,” he says.

39%

Proportion of total infra capital raised in 2021 accounted for by sector-specific funds

$5.4bn

Amount raised by infra secondaries funds closed in H1 2022

Active management is another clearly signposted direction of travel, given both the challenging macroeconomic backdrop, characterised by high inflation and rising interest rates, and the digital and energy transformations required of many infrastructure assets.

“You need to be at the steering wheel, with your foot on the accelerator or the brake depending on the prevailing conditions,” says Ian Harding, managing partner of Arcus Infrastructure Partners, which has transitioned its strategy to one of controlling interests as a result of the need for a hands-on approach. “It is all about analysing the environment you are in and trying to react to it in a proactive and dynamic manner.”

Buckley also sees managers pushing the boundaries between the definition of private equity and infrastructure as another example of strategic evolution. “Finally, the energy transition will likely lead to the development of natural capital as a standalone asset class,” he says. “While the sector is still in its infancy, there is no better way to decarbonise the planet than by growing trees or regenerating soil.”

5

Launching specialist vehicles

Infrastructure is increasingly segmenting by sector, geography and size. Further specialisation is on the way, led by energy transition and digital infra plays

Last year, digital infrastructure specialist DigitalBridge closed its second flagship fund on $8.3 billion, surpassing its $6 billion target and propelling it into the top 10 infrastructure funds ever raised. Other sector specialist behemoths include Brookfield’s $15 billion energy transition fund, which closed at almost double its initial target and $2.5 billion over its hard-cap in June.

According to data collected by Infrastructure Investor, sector-specific funds were responsible for 39 percent of total infrastructure capital raised in 2021, and the trend shows no signs of abating. “The energy transition is on track to becoming its own asset class at scale, served in part by a growing universe of specialists,” says Campbell Lutyens’ Gordon Bajnai.

“In fact, we are seeing specialisation within specialisation, with some managers focusing on lower-returning brownfield strategies and others on developing platforms or newer technologies. The other area where we are seeing meaningful specialisation is in digital infrastructure, where DigitalBridge is the natural leader in terms of size and global reach. And there are a lot of mid-market funds being raised as well, particularly in the US. Although the jury is still out, as some of the diversified managers have first ranking sector teams as well.”

“I think it’s natural that as the infrastructure market deepens, other forms of specialisation
will emerge”

Paul Buckley
FIRSTavenue

Regulation, coupled with demand from large LPs, has encouraged specialisation in the energy transition, while the pandemic highlighted the essential nature of digital infrastructure. Both sectors are broad enough to warrant specialisation and are also highly complex, benefiting from deep operational expertise.

“At the same time, investors realised through the pandemic that they were under-exposed to digital infrastructure with their generalist managers,” says Bruce Chapman, co-founder of placement agent Threadmark. “They have also increasingly been setting their own climate objectives. Together, this has driven demand for these specialist digital and energy transition funds.”

Increased specialisation by geography is also a current trend, particularly through pan-Asian strategies, as well as managers focusing on growth markets, such as Africa. We may also see more greenfield specialist funds come to the fore, on the back of ambitious government programmes to stimulate economic recovery.

As the asset class continues to mature, it is becoming increasingly stratified by size as well, with a flourishing lower and upper mid-market alongside the mega-managers. “I think it’s natural that as the infrastructure market deepens, other forms of specialisation will emerge,” says FIRSTavenue’s Paul Buckley.

Chapman, meanwhile, suggests we may start to see more smart city funds, encompassing a range of sectors including the energy transition and communications. And, of course, we are already starting to see hyper-specialised funds in emerging technologies such as hydrogen.

6

Pivoting to active management

In a brutal macroeconomic environment, many firms have adopted a hands-on approach

Active asset management, also known as operational value-add or simply alpha generation capability, has shot to prominence as a result of rocketing inflation and spiralling interest rates. “If interest rates rise then the role of financial engineering in value creation falls,” says Campbell Lutyens’ Gordon Bajnai. “Going forward, GPs will differentiate themselves based on their development and operational value creation capabilities.”

In addition to the dwindling role of leverage in returns generation, many assets are facing existential challenges and require meaningful restructuring, often as a result of shrinking demand, changing operating environments or supply-chain disruption. “You need in-house operational expertise to take on these tasks,” says Bajnai. “It may be more costly for the GP but going forward it is the only answer.”

Julien Bedin, co-head of infrastructure investment research at Partners Group, agrees that the macroeconomic environment will emphasise the importance of a hands-on approach. “Active asset management and value creation has become increasingly important for transforming infrastructure assets, particularly as we enter a more challenging macroeconomic backdrop,” he says.

Paul Buckley of FIRSTavenue, meanwhile, points out that active asset management is gaining in prominence as more infrastructure strategies play on the boundaries with private equity. “In infrastructure, value creation draws on the established buyout fund model and infrastructure funds are increasingly asked to demonstrate a value-creation team,” he says. “This team becomes more critical as infrastructure GPs take on greater project development risks or migrate towards strategies that are on the border of private equity and infrastructure.”

7

Democratising infrastructure

Retail investors are clamouring for access to infrastructure, but who are the likely beneficiaries?

Earlier this year, KKR laid out plans to open up its infrastructure and private equity products to individual investors, in a move that reflects the growing excitement around the opportunity to democratise real assets by tapping into high-net-worth and even retail markets.

The potential returns carry significant allure for these investors, particularly given the dire performance of public markets in recent months. Discussions are also underway to amend the EU’s Alternative Investment Fund Managers Directive to expand the definition of professional investor to help bring private markets and private individuals together.

“The distribution of private funds to retail investors has been enabled by deregulation and stimulated further by the attractive fees and distribution economics of private funds versus public debt and equity funds,” says FIRSTavenue’s Paul Buckley.

“Large fiduciaries are building their own internal wealth channel distribution while several innovators are building independent platforms. Meanwhile, the wild west of private fund distribution involves the tokenisation of private fund interests, [which] is still in its absolute infancy.”

Gordon Bajnai of Campbell Lutyens, meanwhile, points out that in the world of infrastructure, retail customers are only willing to engage with global brand names. “This route is only open to the largest players, who are already widely known because of their scale or across different asset classes, such as private equity and private credit,” he says.
Bajnai adds that retail investors are also typically looking for higher-returning strategies, making the democratisation of infrastructure more relevant for value-add than for core funds.