Infrastructure investment in a post-COVID world
Infrastructure investment in a post-COVID world
Head of Alternative Investments, Simon Burgess, examines how investors may turn to infrastructure as governments look for support in completing projects and rebooting economies.
Ever since the global financial crisis of 2008, the investment landscape has presented a whole spectrum of challenges and opportunities. In the immediate aftermath of that crisis, stock markets endured extended periods of volatility and interest rates around the world fell to historic lows, where they have largely stayed since.
While stock market swings might have provided some buying opportunities, investors started to look beyond the more traditional equity/bond approach in order to realise returns. Alternative assets have been one of the largest beneficiaries of this, with figures showing that the sector, which includes private equity and infrastructure, has grown steadily, rising from $3.1trn assets under management in 2008 to $8.8trn in 2017, and is predicted to grow to around $14trn by 2023.
The COVID-19 pandemic has, if anything, reinforced a focus on alternatives, owing to the increased volatility seen across global stock markets. And it is infrastructure that has the potential to be the big winner.
Infrastructure in itself is something of a broad church, covering projects such as renewable energy, utilities, transport and logistics, social infrastructure (hospitals, schools, community housing), and digitalisation via 5G and broadband extensions. Investment in infrastructure is popular with investors, mainly because of the long-term sustainable income streams from projects that are often backed by governments.
Renewable energy is worthy of particular note here, especially in view of net zero carbon targets that are being established in countries around the world and through accords such as the Paris Agreement. This drive to carbon neutrality will create a significant infrastructure investment need.
It is generally recognised that governments around the world can’t complete the projects important to them without private finance help. Indeed, according to the G20's Global Infrastructure Hub initiative, as at April 2019, there is a $15 trillion infrastructure investment gap. Between now and 2040, it is estimated that $94 trillion of investment is required but only $79 trillion is likely to be funded.
The COVID-19 pandemic may well make that gap even wider. With governments around the world having to provide economic support to individuals and businesses, they may have to increasingly rely on external investment to complete essential infrastructure projects. And with investors typically only allocating less than 5% to infrastructure, an increase in allocation could help close the gap.
Foundations for growth
So, a seemingly golden opportunity, but it also begs the question how ‘safe’ infrastructure investments are. The caveat, as always, is that most investments come with an inherent risk. But consider the forecast from Morgan Stanley that a 60% stocks/40% bonds portfolio will only deliver a 2.8% average annual return over the next 10 years, compared with about 6% over the last 20 years.
This has driven many investors not only to look elsewhere, but to accept more risk – in some instances entering high-risk areas such as tech start-ups and cryptocurrencies. But this is where infrastructure offers something special.
Over the last 10 years, core infrastructure has shown it remains uncorrelated to equities or bonds, as well as offering risk-adjusted returns. What's more, Preqin data shows that infrastructure returns over last 10 years have averaged 8.9% (compared with global equities at 7%, bonds at 3% and PE of 15%).
Infrastructure revenues are generally less vulnerable to economic cycles or changes to monetary policy. And projects are often tied to public goods or services, with revenue often linked to inflation. Critically, in an environment where bond yields remain flat, investor demand for longer-term debt suits infrastructure projects.
The current global economic environment is also conducive to infrastructure investment. Dynamics such as Brexit uncertainty, trade wars and the potential for recessions in major economies have increased demand for safe-haven, long-dated investments or diversification. Indeed, many UK investors are focusing on UK infrastructure, citing concerns over Brexit, stock market volatility and a preference for predictable income.
Added to this, there are growing calls from some renowned economists for the UK government to issue undated bonds to pay for COVID support and stimulus packages. If this were to happen, it would support or enhance the raising of longer-term debt to support infrastructure projects.
Naturally, it is worth sounding a note of caution around any investment. A jump in investor demand for infrastructure could, for instance, result in a bubble for certain types of assets, which could always burst. Key is for investors to plan for the long not short term.
Similarly, infrastructure investments are typically valued off the back of future income forecasts. But these don’t always result in the levels expected. Toll roads are a good example of this – add in COVID-related travel restrictions and cashflows will be impacted.
The road to success
For investors considering infrastructure investments, diversification is key, and this is why the route to market is typically through pooled funds. Despite the COVID-19 pandemic and ongoing economic uncertainty, the market has been active in 2020.
The Macquarie Infrastructure Partners V fund raised around $4bn in total capital commitments in the first eight months of the year, which it will invest in North American infrastructure projects in the transportation, utilities, energy and communications sectors. Those commitments came from 75 limited partners (LPs).
In May, I Squared Capital launched its third global infrastructure fund with a target of $12bn, with its first close expected by year-end. It plans to target mid-market transport, energy and utilities deals in the United States, Europe and select high-growth economies in Asia and Latin America. It already has a number of commitments in excess of $100 million from investment and pension funds.
More broadly, the market looks robust. According to Infrastructure Investor, there are currently 230 GPs in the market, looking to raise a total of $168 bn.
As an organisation that works closely with institutional investors (including state pension funds, sovereign wealth funds and fund managers) to enable them to invest in real assets (which include infrastructure) either individually, in joint ventures or pooled funds, Ocorian's funds team is optimistic about the road ahead for infrastructure investment.
As governments around the world look to kick-start their economies and create jobs while undertaking essential infrastructure projects, and investors look for long-term returns amidst ongoing uncertainty, the two complement each other perfectly.
Our infrastructure funds services team provides specialist fund directors, experienced administrators and fund accountants to help you establish and run your infrastructure fund, freeing your time to focus on value-adding activities. You can learn more about our infrastructure service offering here or contact me below.