Infrastructure is in the throes of its first major crisis as a fully fledged asset class. The industry emerged in a period of profound tumult following the global financial crisis, when it offered the promise of long-term stability and insulation from macroeconomic shocks. With the outbreak of covid-19 and the unprecedented economic freeze that followed, those promises are now being tested.

The pace of change over the past decade has been breakneck. Infrastructure no longer refers solely to monopolistic, contracted assets that are capital-intensive, display low volatility and are hedged against inflation. As the parameters of the industry have expanded to incorporate a wider set of sectoral characteristics, many segments of infrastructure increasingly involve significant GDP sensitivity and technical risk.

A risk lexicon has been developed to help investors navigate this ever-more complex landscape. The terms core, core-plus, value-add and opportunistic were borrowed from infrastructure’s big brother, real estate. Yet the suitability of the taxonomy that was employed to demystify a heterogeneous asset class has long been questionable, and never more so than now.

Although it is generally accepted that core investments are lower risk than core-plus, and that core-plus assets are less risky than opportunistic or value-add, definitions of these buckets vary wildly. This gives managers plenty of leeway to either assuage risk concerns or justify higher fees by using these labels in their marketing spiel.

“At the moment, almost every manager is trying to position their strategy as being, in some way, core”
Anish Butani

“At the moment, almost every manager is trying to position their strategy as being, in some way, core,” says Anish Butani, senior director, private markets, at bfinance. “We even see managers calling themselves ‘value-added core’.

“Most GPs try and incorporate the word ‘core’ into their marketing somewhere. At the same time, some GPs that are very much core-plus in nature like to use the expression ‘value-add’ to help them justify a higher fee proposition. The terms are used interchangeably.”

Covid test

The global pandemic and international lockdowns have put infrastructure’s resilience claims to the test. And the inadequacy of these broad categorisations is becoming all the more apparent.

“Some assets previously considered to be core in nature have been impacted seriously by the crisis, and even now the shape and extent of their recovery is uncertain,” says Simon Gray, co-managing partner at Arcus. He cites transport infrastructure that is ultimately paid for by end users – such as airports, ferries, toll roads and some rail investments – as a prime example.

He adds that other infrastructure investments that were perceived to be higher risk have the opportunity to emerge stronger after the crisis, such as telecom segments like data centres.

“As a general rule of thumb, people take great comfort from using history to calibrate their views on the future – and on the whole this approach has served us pretty well,” he says. “However, it tends to break down in situations where the pace of change is very rapid or there are discontinuities.”

Evidence of that pace of change is everywhere. The energy space has shifted from a centralised, predictable thermal model to the distributed, intermittent, green world of today. The irrevocable momentum behind the energy transition is poised to revolutionise the transport industry, while telecoms innovation over the course of 10 years has transformed just about every aspect of the way we work and live. The risk profiles of sub-sectors have therefore morphed as their dynamics have changed.

“We have seen boundaries being blurred as a function of the disruptive forces affecting certain assets,” says Vittorio Lacagnina, head of business development for the Americas, infrastructure, at Partners Group.

He points to assets historically classified as core, including regulated utilities such as California’s PG&E and UK water companies, which have faced disruption risk and regulatory headwinds, thereby shifting their risk/return profiles.

“The UK is experiencing disruption within its water infrastructure, which is likely to face a shortage in the next 25 years in the absence of critical resilience planning,” he says. “On the other hand, communications would not have been classified as infrastructure even just five to 10 years ago. Now, fibre networks and telecom towers are increasingly being seen as infrastructure due to the essential service they provide – especially during covid-19. They are seen as the next utility.”

A moveable feast

Although these risk categorisations have proved transient, they are not without their uses. For individual investors, which have formed their own interpretations, they have proven indispensable for allocation policy and portfolio construction by providing the framework for a consistent approach to factors such as business plans, the regulatory environment, leverage levels, stages of development and other market dynamics. For GPs, they provide a starting point for conversations with investors and – theoretically, at least – keep them honest when it comes to strategy drift.

“Today, investors want to know what type of infrastructure they are investing in, and having these segments can be helpful in driving closer alignment with their investment strategy”
Alastair Yates

“These labels have been in the market for a number of years and have evolved over time in line with the growing sophistication of investors allocating to the sector,” says Alastair Yates, managing director at Macquarie Asset Management. “If we look back even 10 years ago, some investors would have been allocating to infrastructure without necessarily differentiating between sub-sectors. Today, investors want to know what type of infrastructure they are investing in, and having these segments can be helpful in driving closer alignment with their investment strategy.”

For Butani, the boundaries of these risk buckets are clear. “Core involves assets that are, at their heart, contractual,” he says. “You should be able to turn the lights out, go to sleep and come back and find everything still operating.”

Meanwhile, Butani deems core-plus to involve assets with GDP exposure, and value-add as assets that may have some aspects of instability now but that, with active stewardship, will likely acquire the monopolistic characteristics and innate demand to make them core in the future – so called ‘build-to-core’.

“These assets may not be core today, but with some element of stabilisation, buy and build, contracting or carve-out, they may achieve that status,” he explains. “Those assets could then be sold to a long-term, yield-focused buyer.

“It is interesting that while value-add is higher up the risk/reward spectrum, there is a potential to re-rate once stabilisation activities have taken place. Core-plus, however, may always remain core-plus because of the inherent GDP volume risk attached to it.”

Using this definition, it may be core-plus assets, rather than value-add, that find themselves in the eye of the storm. Their exposure to greater risk as a result of the pandemic could lead to some rethinking around risk/reward fundamentals.

On the same page

But obsessing with labels may be missing the point. What is most important is that the risk associated with an individual transaction is fully understood by both manager and investor, regardless of what label either attributes to it.

Take transport, which would be considered core by some investors, but not by others. In reality, it is impossible to generalise, and some sub-sectors and geographies have been far more severely impacted by covid-19 than others.

“The motorway recovery is nearly over,” says Laurent Fayollas, senior managing director at Ardian Infrastructure. “Commercial traffic in France is already slightly above 2019 levels for HV; and now the summer season has arrived, light vehicle travel is likely to follow that trend. Even within airports, you see variations between those focused on domestic traffic and those dominated by long-haul flights.”

“Risk terminology has been widely debated from the start, and there is certainly room for clearer definitions,” adds Lacagnina. “There is no denying that the industry will continue to debate these labels. But the key is to maintain discipline within one’s infrastructure investment strategy and avoid style drift.”

Yates says these labels can act as rangefinders for investors trying to navigate the infrastructure landscape, but admits they are certainly not perfect: “One manager’s super-core is another manager’s core. There is room for a lot of variation depending on how different managers think about different risks. It is therefore really important that investors look under the hood to try and understand the strategy and real risk profile of an infrastructure business.”

It is clear then that these labels mean different things to different people. Investors must therefore dig beneath the surface of individual GP strategies and the assets within a portfolio. Equally, GPs must dig beneath the surface of an LP’s risk appetite to ensure that they can deliver on its specific needs.

“It is very important when talking to LPs and prospective LPs that you understand what they have in their mind beyond the terminology,” says Fayollas. “You need to agree on what will be going into that portfolio, because successful GPs are those that deliver on their promises.”

“The terminology is helpful, but only to a degree,” adds Butani. “I would always encourage anyone to scratch beneath the surface and to understand what risks they face at an asset level. Labels can support portfolio construction and planning, but rest assured: outcomes will always be driven at an asset level, and those assets can vary considerably.”