Brookfield’s $15 billion final close for its energy transition fund earlier this year heralded the arrival of the net-zero infrastructure mega-fund. At more than double the fund’s initial target, and a full $3 billion above its original hard-cap, this momentous achievement also cemented the energy transition as its own sub-asset-class in an infrastructure industry that is becoming increasingly specialised.
The energy transition is not the only pocket of specialisation to have established itself in the mainstream in recent years. DigitalBridge amassed $8.3 billion for its latest digital infrastructure offering at the end of last year – an eye-watering amount for a sector that has historically been relegated to the mid-market. The vehicle was also the largest sector-specific close of that year.
Indeed, according to data from Infrastructure Investor, sector-specific funds were responsible for 39 percent of total infrastructure capital raised in 2021. This is the largest proportion in at least a decade, and up from only 17 percent in 2020.
This evolution is not unexpected, however. As markets grow, they deepen and also stratify. “Broad was beautiful back in the early 2000s,” says Bruce Chapman, co-founder of placement agent Threadmark. “At that stage, most investors were still putting the first building blocks of their allocations together and were looking for funds that had exposure across multiple sectors and risk profiles. But as the asset class has matured, and as investors become increasingly sophisticated in their approach to portfolio construction, we are seeing greater levels of specialisation.”
The renewables sector was the early beneficiary of this trend. Back in the late 2000s there was a proliferation of specialist strategies, some of which were extremely niche, such as onshore wind in the UK, or solar in Spain. But as generalists piled into the sector and feed-in tariffs tapered, returns suffered and appetite waned.
The covid-19 pandemic then coincided with a renewed sense of urgency around climate change, while war in Ukraine heightened energy security concerns. These concerns led to a resurgence of interest in funds focused not just on renewables, but the energy transition more broadly. Indeed, green infrastructure has resoundingly become the most successful specialist strategy in the past 18 months, with Copenhagen Infrastructure IV and BlackRock’s Global Renewable Power Fund III joining Brookfield in storming to impressive closes.
“There has been a confluence of factors that has crystalised in the energy transition becoming by far the largest specialist sector,” says Gordon Bajnai, head of global infrastructure at private capital advisory Campbell Lutyens. “The regulatory environment – with Sustainable Finance Disclosure Regulation in the EU and the latest US Securities and Exchange Commission rules that are still under discussion – coupled with demand from large LPs that will only invest in sustainable strategies, has encouraged specialisation. The energy transition is also a sector that requires specialist knowledge, and there is a big market map, with lots of GPs focusing on different strategies.”
The pandemic also highlighted the essential nature of digital infrastructure – another highly complex sector that benefits from deep operational expertise. “Many of the sub-segments of digital infrastructure – like DAS, small cells, colocation data centres, WiFi and enterprise fibre – cannot be managed passively,” says Kevin Smithen, chief commercial and strategy officer at specialist manager DigitalBridge. “These businesses have very high growth rates but are operationally intensive.”
Covid also revealed hidden concentrations in generalist funds, says Chapman: “Some of the larger managers that have become dominant over the past decade had made some fairly concentrated bets in conventional energy, in particular, but also transportation in the run up to covid – two sectors that have clearly been facing headwinds.
“At the same time, investors realised they were under-exposed to digital infrastructure with their generalist managers. They have also increasingly been setting their own climate objectives. Together, this has driven demand for these specialist digital and energy transition funds.”
Importantly, energy transition and digital infrastructure are both sectors that are broad and driven by secular themes, making them ideally suited to specialisation. “There is a danger with specialist funds that are in cyclical sectors – but these are both sectors with long-term growth prospects,” says Paul Buckley, managing partner at placement agent FIRSTavenue. Indeed, digital-focused funds raised 31 percent of sector-specific infrastructure capital in 2021, closing the lead on renewables at 50 percent, according to data from Infrastructure Investor.
Local versus global
Infrastructure firms are not only specialising by sector. In addition to home-grown US and European houses, we are now increasingly seeing pan-Asian strategies, such as those managed by Macquarie and KKR. Then there are the Australasia-focused firms, including Pacific Equity Partners, which is currently raising its second vintage.
Elsewhere, there are managers specialising in emerging – or growth – markets. Actis is a notable example here; the manager employs a specialisation strategy with a range of products including an energy fund, while it is understood the firm is also poised to raise a fund focused on digital infrastructure. Meridiam, meanwhile, is one firm that has forged a niche in the African market, alongside its European and US strategies.
In both 2021 and H1 2022, 75 percent of infrastructure funds closed were focused on a single region, data from Infrastructure Investor reveals. This is up from 69 percent in 2020, and the highest figure since 2018.
Smithen says that localised strategies proliferated post-pandemic. “During covid, the need for boots on the ground and local expertise in Asia, Latin America, the Middle East and Africa, among other markets, became more important than ever.”
Bajnai, meanwhile, adds that regional specialisation makes sense if that specialisation represents a barrier to entry. “In other words, if the market is not easily understood by global players.”
Another longstanding form of specialisation involves greenfield versus brownfield investing, where the expertise required can differ significantly. “Greenfield investing is more about project finance, and about dealing with governments, local authorities and construction firms – holding them to budget and deadlines,” says Bajnai.
Demand for greenfield skills is likely to grow in the coming years, driven by ambitious government infrastructure programmes around the world.
And then, of course, infrastructure is increasingly specialising by risk-return profile, having adopted terminology from real estate. The distinction between core and value-add is the most well recognised, but definitions have evolved to also include super-core, core-plus and opportunistic, with returns expectations ranging from the high single digits to the high double digits accordingly.
Finally, in an inevitable reflection of the industry’s maturity, infrastructure now has a well-established mid-market feeding into the large-cap and mega-market space. “A number of our investors were particularly attracted by our mid-market focus, which provides differentiation from some of the larger funds, with smaller assets and different subsectors,” says Jessica Kennedy, managing director at manager Northleaf Capital.
“It’s the classic question of risk diversification versus realising potentially higher alpha and sector beta”
Out with the old
Are LPs really ditching mega-managers and their generalist behemoths in favour of more specialised alternatives? Robert-Jan Bakker at manager Partners Group emphasises that the two strategies are not mutually exclusive. “Many LPs want both,” he says. “They look for global, proven generalist funds to seed their portfolios, and then accentuate those portfolios with specialised managers, depending on their individual goals.”
Smithen, on the other hand, says LPs are waking up to the advantages of specialisation. “It’s the classic question of risk diversification versus realising potentially higher alpha and sector beta,” he says, describing the conundrum facing investors. “There are segments of infrastructure that are in secular decline or are unfriendly from an ESG perspective. Generalist funds will need to try and deploy more into energy transition and digital to compensate, but they are at a disadvantage relative to specialists.”
Indeed, Smithen adds that his firm is hearing, anecdotally, that LPs are beginning to push back on generalist mega-managers and allocate more to specialists, although he acknowledges that this rebalancing is still in the early stages.
Increasingly, however, it seems that the reality may be falling somewhere between the two. The pandemic forced a rapid consolidation of the private funds industry as restrictions on meeting new managers made it hard for LPs to get new GPs through the system, meaning capital aggregated around the big brands. Those big brands responded with a proliferation of specialist product launches alongside their flagship funds, adopting strategies such as super-core, mid-market and infrastructure debt, or with a focus on Asia or the energy transition.
Even though travel restrictions have since eased, the market for emerging managers remains incredibly challenging.
“During covid, capital flooded to the well-known, approved fiduciaries, and that forced a massive one-off consolidation, but I don’t think it is a trend that will be reversed,” says Buckley. “There are still new managers raising funds, but the big winners in this industry are the mega-GPs that are branching out with new strategies.”
It is not a model without flaws, however. “Some groups have successfully leveraged a strong brand to use the constraints of covid to expand their product line,” says Chapman. “And that is super smart. But investors really need to think carefully about the rationale for their doing so, as well as the way the manager is staffing the new fund. Are there high-quality individuals capable of executing the new strategy? Has the manager raised the right amount of money and incentivised the team appropriately? We are not critics of this approach at all, but we typically prefer independent groups that have a single focus because we feel history has proven that they tend to be more successful.”
“Investors realised they were under-exposed to digital infrastructure with their generalist managers”
The next generation
That is not to say that we won’t see new managers join the asset class, of course. In particular, we will see fresh faces in the mid-market space. “The top 10 managers now represent roughly 50 percent of AUM growth every year,” says Bakker. “But you also need smaller funds to make sure that assets mature to the right size, so I do think there is opportunity there.”
Chapman agrees: “There are not that many managers in that smaller-cap space, and the best tend to migrate out pretty quickly,” he says. “There is also strong proprietary dealflow in that part of the market and therefore the opportunity to capture higher returns and be more creative with assets.”
But while we may see small- and mid-cap generalist firms entering the fray, elsewhere new managers are likely to be predominately specialists – not least in light of a more challenging economic environment. “The last decade has seen the golden age of infrastructure as an asset class,” says Smithen. “The next 10 years will be harder, and true value-add returns will be more scarce. Specialisation is definitely here to stay.”
Who’s next to go solo?
It seems inevitable that other sectors will follow energy transition and digital infrastructure down the specialisation road.
FIRSTavenue’s Paul Buckley points to social infrastructure as a likely contender. “I think it is natural that as the infrastructure market deepens, other forms of sector specialisation will emerge,” he says. “Social infrastructure strikes me as something with the potential for significant growth, particularly now, in the midst of a massive global squeeze on the middle class. Governments are under pressure to stimulate the economy and to appease key stakeholders who feel disadvantaged, and so I expect social infrastructure to come to the fore.”
We may also see more infrastructure funds focused on themes as opposed to sectors – akin to the energy transition. Threadmark’s Bruce Chapman suggests smart cities could be one example, encompassing a range of sectors including the energy transition and communications.
As technologies develop and as the asset class continues to expand its reach, we can expect further iterations of infrastructure’s sector specialisation trend. Indeed, we are already seeing funds focus on niche industries within the energy transition, such as hydrogen, for example, where manager Ardian has raised at least €800 million against a €1.5 billion target in a new joint venture.