Solid foundations: the infrastructure opportunity

During the last decade private infrastructure has grown from an esoteric asset class on the periphery of the private markets ecosystem into a mainstay of alternative asset portfolios.

In 2010 infrastructure assets under management (AUM) only totaled less than US$170 billion, according to Preqin figures, but during the following decade infrastructure AUM have grown at an annual compound rate of 16 percent and now exceed US$1 trillion.

The steady long-term cashflows and relative low volatility that characterize the asset class have made infrastructure one of the fastest growing areas of private market.

The strategy, of course, hasn’t been immune from the wider headwinds that have faced private markets through the recent interest rate rising cycle. Infrastructure fundraising has declined for three years in a row, falling to the lowest levels in a decade in 2024.

Over the long-term horizon, however, infrastructure remains a highly attractive investment strategy for pension and sovereign wealth funds that want to diversify their private markets portfolios and build exposure to assets that offer inflation protection and stable, uncorrelated investment returns.

Even as AUM have skyrocketed, many investors are still under-allocated to infrastructure, with a survey of more than 100 investors in 20 countries by Cornell University’s Program in Infrastructure Policy and advisory firm Hodes Weill Associates found the almost two thirds of public and private pension funds said they were under-allocated to infrastructure, while global institutions, on average, reported being 1.23 percent below targeted allocations.

After a challenging 36 months, prospects for fundraising are looking up, demonstrating long-term investor appetite for exposure to the asset class.

Infrastructure Investor estimates that the ten largest funds in the market will seek to raise more than US$143.63 billion between them alone during the next year, while asset manager Schroders sees fundraising rebounding back in line with historical patterns.

With the private infrastructure industry set for a period of sustained growth, Alter Domus provides a detailed breakdown the attributes that make infrastructure such an attractive investment strategy for long-term institutional investors.

1. Assets with predictable cash-flows

Infrastructure assets, such utilities, transport networks, schools and hospitals, provide essential services funded by non-discretionary spending, with demand sustained across investment cycles.

As providers of essential services, infrastructure assets and operators benefit from long-term financing arrangements fixed contractable revenues, often running for 10 years or more and supported by government guarantees.

The fact that infrastructure provides non-discretionary services makes it easier to pass on high-costs to end users, and many contracts will have inflation-adjustment mechanism provisions, offering a shield against inflation on margins.

Analysis from KKR shows that in cycles of high inflation, infrastructure assets provide superior real returns to equities and real estate.

2. Returns with low correlation to other asset classes

Infrastructure will typically produce returns that have low correlation with other asset such as equities and fixed income. This offers investors attractive diversification benefits, as well as steady revenues and yields through downcycles.

Hamilton Lane analysis shows that the pooled one-year IRR for global infrastructure over the last ten vintage years, has come in at 12.5 percent, and when looking at the highest and lowest 5-year annualized performance periods over the last 20 years, investors in infrastructure avoided the drop off on performance observed in other asset classes.

3. Returns with low correlation to other asset classes

Infrastructure assets will typically have long life spans, making illiquid private markets funds are good structure for holding these assets.

For pension funds, insurers and sovereign wealth funds that have to meet long-term financial liabilities the long hold periods for infrastructure assets (HarbourVest estimates that core infrastructures assets can have asset lives in excess of 100 years) are a good option for matching liabilities with assets to ensure they meet their investment obligations.

4. Solid underlying growth fundamentals

A confluence of global megatrends is driving up demand for infrastructure investment across all areas. There is a long growth runway ahead for infrastructure investors, driven by multiple factors:

• The world’s population has more than tripled since the 1950s, according to the United Nations, driving up demand for energy, transport, water and sanitation and telecoms.
• The world is more urbanized. More than half of the global population now lives in urban areas – up from a third in 1950, according to the UN. The drives particularly intense demand for ongoing infrastructure investment in concentrated areas
• Decarbonization will require existing infrastructure to be retrofitted to reduce energy and emissions, as well as investment in new infrastructure to facilitate the use of renewable energy, as well as battery storage and charging infrastructure to support the switch to electric vehicles.
• The digitalization of the economy, cloud computing and the rise of AI are driving huge increase in demand for investment in data center capacity. According to BlackRock, data center capacity will have to expand at a compound annual growth rate of 22 percent to meet projected demand.
• There is an urgent requirement to upgrading aging infrastructure. According to the American Society of Civil Engineers failure to upgrade existing assets could cost the US economy up to US$4 trillion GDP between 2016 and 2025.

5. Partnering with government to deliver infrastructure

Government budgets are stretched following the pandemic period, especially as borrowing costs have gone up. It will be difficult for governments to meet infrastructure investment requirements without private capital.

Partnering with governments using structures like public-private-partnerships (PPPs), where the private and public sector share the risk and capital expenditure burden of construction new assets, opens opportunities for the private sector to support the build of new infrastructure projects in return for access to stable revenue streams and the appreciation of underlying asset values.

PPPs are designed to share risk between the state and private sector, making it easier for private infrastructure players to invest than taking on greenfield projects without the support of the state.

6. A pathway to meeting ESG obligations

Almost all institutions will be obligated to meet environmental, social and governance (ESG) goals as part of their investment mandates.

Infrastructure assets are well-positioned to align these ESG goals with financial performance metrics. Investments in clean energy, water sanitation or schools and hospitals all present sound commercial investment opportunities, but also drive visible, positive environmental and social impact.

Risks and challenges

Regulatory risk:
Infrastructure can be impacted by shifts in government and regulatory policy, which can disrupt revenue and funding models, particularly for assets developed in PPP deals.

Political risk:
Some jurisdictions can present political risk and even possible expropriation in some circumstances. Protecting infrastructure assets in unstable regions can erode earnings.

Operational risk:
Infrastructure assets are complex and challenging to build and maintain, which can often lead to delays and cost overruns. Construction consultancy Mace estimates that four in five large infrastructure projects globally experience cost or time overruns, while McKinsey analysis shows that 98 percent of mega projects will exceed budgets by more than 30 percent, with more than three in four of these projects subject to delivery delays of at least 40 percent.

A good fit for institutional investor portfolios

It is important for investor to go into the infrastructure segment with their eyes open to these risks, but equally important to recognize that experienced managers with proven operational expertise will be able to mitigate these risks significantly through due diligence and building up diversified portfolios of infrastructure assets.

For institutional investors the benefits of infrastructure allocations to a portfolio far outweigh the risks. The asset class dovetails tidily with long-term private markets fund structures and presents investors with stable, long-term revenue streams that are insulated against inflation and have low correlation to other investment classes and economic cycles. Infrastructure investment also aligns with ESG objectives

As growing populations drive long-term demand for infrastructure, and with governments unable to meet investment demand without private sector capital, infrastructure will remain a key part of private markets portfolios.

---

---