IREI’s VIP Infrastructure conference (formerly i3) reached its 12th year in operation in June in Toronto. In VIP Infrastructure’s early days, many institutional investors — particularly in the United States — were new to infrastructure, and much of the discussion and presentations at the conference were generalized, theoretical and not too specific. Investors would describe their interest using terms such as “educational,” “getting their feet wet” and “information gathering,” and while some of those still apply, what was clearly different at the 2019 event was a focus on the specific and the concrete — everyone is on board with ESG principles, for example, but how are actions based on these principles monitored and reported at a construction site or a power plant, and what is their impact on company and asset performance? Another example of getting into the specifics at VIP Infrastructure is the belief that infrastructure is a defensive asset class. But what can be a defensive asset with the right investment structure and leverage discipline can also be a problem asset with the wrong structure and leverage. It’s not enough to accept that infrastructure is defensive simply because it is infrastructure.
The phrase “peeling back the onion” was a common refrain this year at VIP Infrastructure. Investors, who in earlier years might be “getting their feet wet” and satisfied with fund-level data and information, increasingly want investment managers to drill down into infrastructure portfolios, asking questions about how portfolio companies and assets generate revenue, for example, through leverage, operational efficiencies or investment timing?
A good example of where it will pay off for infrastructure investors to dig deep into the specifics is the renewables sector. For the past 10 years, the trends driving the market and the attractiveness of the sector have been the declining costs and increasing power generation capabilities of solar panels and wind turbines, as well as consistent government subsidies. But that dynamic is changing, as cost declines have largely been realized and subsidies are expected to begin to be phased out over the next two years. The long-term contracts of 20 to 30 years to which investors grew accustomed are thing of the past, too. Instead, the renewables market is increasingly being compared to the power sector rather than infrastructure, and VIP Infrastructure participants believe infrastructure funds will be just as likely to invest in natural gas–fired power plants as they are wind farms or solar facilities.
Peeling back the onion of infrastructure investments and assets also lets investors better answer the question, what is infrastructure? Careful examination of these companies and assets reveals each of these are unique and bespoke investments. No two infrastructure assets are alike because each will have a different geography, investment structure, financial leverage, regulatory regime within which to operate, political system, risks, cost of capital, and so on.
Quick tally polls
VIP Infrastructure attendees were polled throughout the event about issues affecting infrastructure markets.
Attendees identified value-add investments (53 percent) as the most attractive during the current market cycle, followed by opportunistic (17 percent) and core (14 percent). VIP infrastructure attendees expect to allocate more capital to infrastructure during the next 12 months — 72 percent — and 21 percent plan to keep their allocation levels to infrastructure the same. The No. 1 risk for infrastructure investors as gauged by VIP Infrastructure attendees is too much capital targeting too few deals (52 percent), followed by political risk (26 percent) and technology disruption (10 percent).
Additional takeaways from VIP Infrastructure
- Mega-funds continue to suck up all the energy in the fundraising market, with first-time fund managers feeling overshadowed.
- Attendees warned that as investors move up the risk curve and away from core to core-plus, value-added and beyond, they need to be sure they are being compensated for taking the additional risk.
- Governments are infrastructure investors’ most common counterparty, and they are increasingly adding risk to transactions by retroactively recasting the terms.
- The capital distribution to capital call ratio for investors began shifting at the end of 2018. Where distributions previously outpaced capital calls, at the end of 2018, the ratio become about even. This means LPs have less capital to redeploy, and fund managers could see less demand for their products. This could be a leading indicator of a slowdown in the investment/fundraising cycle.
- In a market and economic downturn, some VIP Infrastructure attendees speculated that ESG could be deprioritized as returns and preservation of capital becomes the top priority.