Infrastructure in private equity explained


With demand for infrastructure investment growing, we explain what it is and what it offers investors
- Infrastructure describes assets that provide populations with essential utilities or services
It’s estimated that providing basic infrastructure for all people over the next two decades will require around $15tn of global infrastructure investment. Private infrastructure markets, consequently, are witnessing substantial growth. But this relatively new asset class – only as old as the 1980s – is already in transition, as what makes up infrastructure in the post-fossil fuel era and the embedded digital age changes in line with what populations need to thrive.
Infrastructure in private equity in a nutshell
Infrastructure describes assets that provide populations with essential utilities or services. This means private equity (PE) funds that invest in infrastructure have exposure to sectors such as transportation (e.g. airports, roads, bridges, rail), utilities (e.g. gas, electric, water, and internet networks), social infrastructure (e.g. hospitals, schools), and energy (power plants, pipelines, and renewables like solar/wind farms).
In PE, infrastructure investments are often broken down into four categories:
Core: These are considered the lowest risk, often include infrastructure assets such as electricity companies in developed markets like Europe and the US, and generate most of their returns from cash dividends.
Core-plus: This is a bit riskier, but the investment offers more opportunity for growth. This could be a regulated utility in a developing market, for example.
Value added: where the PE firm would likely need to be involved in some big operational changes to an asset, for example taking a mobile phone operator that only serves London and making it nationwide throughout the UK.
Opportunistic: This is the riskiest type of PE infrastructure investment and often invests in assets that need a significant amount of development or restructuring.
Opportunities and challenges: Infrastructure in PE
As well as the huge financing gap in basic global infrastructure investment, far vaster sums are needed to help meet the world’s sustainability goals, with an estimated $139tn needed to achieve net zero targets by 2040. All of which is contributing to a rapidly increasing demand for PE.
Private equity infrastructure investment also provides an attractive alternative for investors. While the performance of infrastructure assets is often linked to economic factors like GDP, population growth and inflation, it typically (though not always) offers low volatility, a protected downside (i.e. lower risk of falling in value), and stable cash flow. Many infrastructure investments also provide a strong cash yield in the form of dividends and a low correlation to other asset classes (like equities and bonds) making it a good diversifier for an investor’s portfolio.
As essential parts of a society’s ability to function, infrastructure assets are also often non-cyclical, meaning even during a period of economic downturn people will still require electricity, roads and hospitals, for example, so returns on these kinds of investments can be protected to a large extent in certain instances.
PE investment in infrastructure is not without its risks, however. Leverage – i.e. debt – for example, is a common feature of infrastructure investments. Any investment with large amounts of leverage will cost a lot to service that debt in the form of interest payments. This is especially true now central banks around the world have raised their base rates from the record lows seen in the 2010s. The riskiness of a highly leveraged investment can be judged by its ability (or not) to generate enough revenue to outpace these debt interest payments.
The other main risks to investors in infrastructure are regulatory and political. This will often take the form of environmental, social and governance risks, for example, the requirement to take into account the impact on a community when building a new bridge. Or, as seen in the recent example of UK water companies pumping sewage into waterways, the regulator may step in to censure or fine an infrastructure company for its contribution to hazards.
Infrastructure investment is witnessing an evolution
Infrastructure investments have evolved. Traditionally the responsibility of a country’s government, states have used taxpayers’ money to build, for example, roads, water plants and electricity grids, for use by their populations. Private sector involvement in infrastructure is relatively recent, entering the market only in the last 40 years, as public finances have become stretched or political ideologies have moved towards a more capitalist framing.
The types of infrastructure available for investment have also changed. Evolutions in energy, the movement of people and ideas, and digitalization have opened up new opportunities and made others less attractive. Investments in fossil fuel-supported networks, for example, once seen as core and low risk by PE, are now often viewed in the opposite light as these energy sources are phased out on the road to net zero. On the flip side, renewable replacements like solar and wind farms present alternative investment targets for PE infrastructure investors. At the same time, maturing internet infrastructure, coupled with the post-Covid adoption of remote working, have moved internet providers into the core infrastructure sphere for PE investors.
However, newer techs can come with big opportunities but also higher risk profiles.. Electric vehicle (EV) charging networks, battery storage, hydrogen distribution, smart motorway and rail technology, 5G telecom networks, and data centers are the kind of modern real assets PE infrastructure investors are hungry for. But investors in these assets will often have to accept big upfront investments during periods of negative cash flow, as well as the kinds of development, tech and commercial risks that can plague newer infrastructure entrants. That said, bigger risks can offer the chance for bigger rewards in the long run.
How it started and how it’s going
Pre-1980 it was a rare thing to get private equity investment in large infrastructure. The asset class was an arena reserved for governments or corporations. But around the late 80s, 90s and at the turn of the millennium, a few countries such as Australia and Canada pioneered private capital for both the construction of new infrastructure and the monetization of existing assets.
Australian bank Macquarie is often credited as the first to raise PE funds with the mandate to invest exclusively in infrastructure, across Australia, Europe and Canada, where governments were looking to sell state monopolies such as utilities, airports and toll roads. Then came the PE investing directly in businesses that were being privatized. In the early days, the assets on offer usually had a lot of debt – consequently, the 2007/08 global financial crisis led to many infrastructure investors losing in a big way.
Today the PE infrastructure market is more crowded, helped by a decade of record low borrowing costs. Infrastructure is now a favored asset class for pension funds seeking yield and protection against volatile markets. Infrastructure assets under management worldwide have soared beyond $1tn, more than six times their level in 2008, according to data provider Preqin.
This larger and growing appetite for infrastructure assets has led to an expansion in what investors will look at for potential investments, such as the transmission masts that mobile phone networks are increasingly selling, or the data centers that will provide the computing power needed for artificial intelligence projects.
Large private equity firms like EQT have invested heavily in modern infrastructure, in a bid to get ahead of experts’ expectations that in the coming years, trillions of dollars will still need to be invested in, for example, reshoring manufacturing supply chains, building modern digital networks and securing traditional and renewable energy supplies.
In the U.S., the world’s biggest economy, three new pieces of legislation; point to a shifting attitude on net zero. Firstly in the addition of the Infrastructure Investment and Jobs Act (IIJA), which authorizes $1.2tn for transportation and infrastructure spending with $550 billion of that figure going toward “new” investments and programs; likewise the Inflation Reduction Act (IRA), designed to improve US taxpayer services, update antiquated computer systems, and increase compliance and enforcement actions; and finally the CHIPS for America Act, designed to boost investment in domestic high-tech research and to bring semiconductor manufacturing back to the U.S. – although, it is worth noting that the timing and duration of such policies are often uncertain.
Investments in infrastructure, like all investments, carry risks. Past performance does not guarantee future results. Investors should conduct their own research or consult with a financial advisor before making investment decisions.
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