In a market of increasing volatility and uncertainty, unlisted infrastructure has steadfastly done what it says on the tin. Indeed, current market conditions are challenging for unlisted infrastructure which is not immune to the impacts of higher interest rates, inflation, supply constraints, geopolitical tension, cost of living pressures, environmental and regulatory changes, however, given the nature of unlisted infrastructure being less exposed to supply and demand dynamics, it has delivered stability and downside resilience to investors.
Prior to our trip to London and New York, we were keen to test the resiliency of infrastructure, understand how assets and sectors have performed in this climate and consider asset pricing for both existing and new assets. We wanted to better understand the flow of capital into the asset class, the capital raising environment and attractiveness of the sector to global pension funds. Additionally, we explored key opportunities and sectors managers were targeting. Overall, we found that despite the volatility, the underlying fundamentals of the asset class remain strong.
Key takeaways from the meetings were:
- Fundamentals remain strong but investment activity has slowed: Generally, infrastructure returns remain resilient despite macro headwinds. This is largely due to inflation-linked cashflows, pricing power, low-correlation to equity markets, and the ‘essential nature’ of infrastructure.Transaction activity remains muted. Sellers remain hopeful that market conditions return to the halcyon days of low rates, so have either held off selling, or been unwilling to meet buyers’ revised expectations. Where transactions have successfully transacted, there have been no signs of distress or notable discounts. Most of the deals in the market have been driven by the need for capital expenditure.Capital raising and allocations to infrastructure continue, however at a slower rate. Interestingly, while fundraising is taking longer, managers are not scaling back their fundraising targets. Offshore pension funds continue to show a healthy appetite for infrastructure, particularly in the US where they are relatively underweight infrastructure.
- Infrastructure managers are developing sophisticated capabilities: The infrastructure market continues to evolve and grow, more recently with the arrival of large private equity firms entering the space. The number of manager mega-funds is also on the rise, as well as the presence of open-ended, perpetual infrastructure vehicles. This is not surprising given the significant investment opportunities especially in energy transition and communications infrastructure space, combined with the demand for infrastructure investment.This has resulted in increased competition for assets, as such managers are increasing their global footprint and specialisation to stay ahead. On-the ground local knowledge and language is necessary. Industrial know-how and deep sector expertise has become increasingly important both through internal capability and external partnerships.
- Strong tailwinds for energy transition is driving investor appetite and pricing: Energy transition continues to be an area of focus for most infrastructure managers in North America and Europe due to the sector’s strong tailwinds and large capital requirements. Core infrastructure managers continue to invest in assets such as utilities and renewable generation, while managers with a higher risk-return profile are deploying into emerging areas such as renewable fuels, carbon capture and energy storage that require more specialised skills but offer potentially more attractive risk-returns.Pricing for renewable generation assets remains high due to strong demand from strategic investors who are acquiring these assets both for strategic objectives and financial returns, and many infrastructure managers reported finding it challenging to compete in auctions for operational assets and platforms. Supply chain bottlenecks have also driven up the component costs and delivery timelines, increasing the overall costs of greenfield projects.
- Midstream gas assets are seen as investable but investors are being selective: Nearly all managers held the view that natural gas plays a critical role in the energy transition, and this is in line with long term forecasts for gas demand by government agencies engaged in long term energy plans. Some offshore pension funds are also open to gas infrastructure assets in their portfolios. Managers, including specialist energy infrastructure teams, are being cautious and selective, and prefer gas midstream assets with highly contracted and defensive cashflows and where returns are not being driven by exit valuations. Midstream assets that are part of the liquified natural gas (LNG) export chain, such as liquefaction and regasification terminals, are an area of interest for some infrastructure managers due to strong underlying long-term demand for LNG in Asia and other parts of the world.
- Digital infrastructure continues to be driven by growth in data: Digital infrastructure assets continue to be driven by strong growth in data consumption and computing requirements, and the emergence of AI computing has the potential to further increase the demand for digital infrastructure. Gains in computing efficiency are also being more than offset through absolute growth in data demand. Most digital infrastructure assets have performed well but there are pockets where assets have been challenged, primarily due to aggressive acquisition pricing, overly optimistic business plans, competition from overbuild, and construction cost inflation. Core-plus and value-add managers are the main investors in this space due to the generally higher risk-return profile of digital infrastructure, but core managers are making investments in tower platforms and stabilised fibre assets.
Conclusion: The key takeaway we had as we completed the research trip was that while infrastructure assets are not immune to the currently challenging broader macro sentiment, infrastructure as an asset class has largely delivered on its objective of downside resilience and a stable return profile. The asset class’ resilient nature is reflected in returns – the MSCI Australia private infrastructure fund index1 has delivered 1 year and 5 year returns of 9.5% and 9.0% p.a. as of March 2023. Transaction activity and fundraising have slowed down but infrastructure assets, particularly in the energy transition and digital infrastructure sectors, continue to see strong fundamental tailwinds due to the critical services they provide, making them a critical part of a diversified portfolio.
1 MSCI Australia Quarterly Private Infrastructure Fund Index (Unfrozen) – AUD, March 2023
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