Within global private markets, infrastructure assets under management are estimated to be $726 billion, or about 7 percent of the $10 trillion in private markets and 14 percent of the market size for private equity. There is positive momentum in fundraising, with more than $300 billion raised for the period 2018-2020, keeping pace with private equity and debt as the fastest growing asset classes among private markets.
Most of these assets are held by institutions. Individual investors in the United States have small allocations to infrastructure, with estimates ranging from 2 percent to 3 percent as a distinct asset class. Expect this to change materially in the coming years as infrastructure features prominently in several global trends and managers create more accessible structures for individuals. Now is the right time to prepare for significantly higher adoption rates and allocations for those who best understand the asset class, its components and how they fit into a total wealth portfolio.
Infrastructure is a long-term investment. There is no need to rush in, and investors should not plan on a quick exit. Instead, plan for infrastructure to be a foundational element of a diversified portfolio, constructed to achieve traditional investment objectives. Infrastructure investments can provide income, growth, inflation protection and capital preservation, depending on the specific assets held. Meanwhile, the nature of the underlying operating businesses and projects can provide stability in numerous market environments.
DRIVERS OF INTEREST
For individual investors, domestic and global trends are generating heightened interest in the space. In the United States, the Infrastructure Investment and Jobs Act announced $1.2 trillion of government spending over the next decade, including $550 billion of new spending in addition to $450 billion of renewals for existing spending. This is the beginning of an effort to narrow a longstanding funding gap in aging and outdated transportation, communications and other essential utilities.
The act provides a useful map of infrastructure sectors and a relative measure of where the U.S. government intends to spend. For new spending, it includes more than $280 billion for transportation, with roads and bridges, rail and public transit representing the leading categories. Lesser amounts are earmarked for airports, ports and waterways, and electric vehicle infrastructure. Outside of transportation, power infrastructure and broadband represent the largest indications of future spending.
Importantly, new areas of spending will provide opportunities for private investment alongside public funding. The act gives private investors rights to own and operate surface transportation assets including roads and rails. Public-private partnerships (PPP) are also referenced and these structures are worth tracking to confirm the legislation is unlocking more private investment in the coming years.
The need to better maintain U.S. infrastructure is made more urgent by the specific natural threats posed by climate change. The global focus on climate change will continue to thrust infrastructure into the headlines with debates on the best pathways to decarbonization, the transition to renewable power sources, and more efficient distribution and storage of power. Furthermore, the ongoing global pandemic will continue to highlight weak links in global supply chains and the crippling effects of the digital divide in healthcare, education and economic opportunity.
Low carbon power, including renewable energy sources as well as the transition of our energy supply to lower carbon emission sources, has been one of the strongest investment themes of the past decade. This is broadening beyond wind and solar to include investment opportunities in other alternative energy sources, such as hydrogen, plus innovative delivery mechanisms and storage solutions. These sectors will be driven by demand for more sustainable energy as well as significantly improved profitability, as technology and broader adoption drive down costs of production. Globally, there is a significant and growing focus on assets and projects that provide climate solutions in all industries. This includes specific targets for decarbonization and reduction of emissions with emerging emphasis on energy offsets and carbon recapture.
Digital infrastructure is another focus and includes broadband, fiber networks, cell towers, data centers, smart meters and satellite internet. Providing high-speed internet to a broader base of the population is essential to closing the digital divide that has been painfully exposed during the pandemic.
HOW IT AIDS THE PORTFOLIO
Infrastructure total return opportunities are driven by managers’ ability to source and underwrite projects and assets that have growth and value-add opportunities in addition to visible, long-term revenue streams. Managers with flexibility will invest across sectors and geographies and will seek a mix of brownfield and greenfield projects where they can leverage control and operating excellence to create revenue growth and operating efficiencies to drive value creation. The adviser’s role can be to help individual investors identify the managers who are best positioned to capitalize on hard-to-find and complex situations.
Individual investors will also be attracted to cash yields that range in the high single digits for infrastructure investments and are uncorrelated to traditional credit and fixed-income assets. This income results from the same contractual revenue streams that provide inflation protection. Sources of income will be observable in the portfolio in the form of long-term contracts tied to corporate power purchase agreements, usage volume for transportation, delivery for midstream assets. Individual investors will be attracted to yields that can be multiples of the dividend yield on the S&P 500.
Inflation protection is another appeal for individual investors. Protections against inflation stem from the fact that demand for essential resources and services is relatively inelastic to price. Trends driving infrastructure spending, including digitization and decarbonization rely on assets that are unique and in relatively low supply due to technological and engineering barriers to entry. Long-term infrastructure opportunities also benefit from revenue streams that are underpinned by long-term contracts, some of which have direct inflation-linked pricing. Experienced infrastructure managers also utilize these long-term contracts to avoid or limit direct commodity price exposures.
Having briefly covered the what and why of infrastructure investing, let’s shift our attention to the how. The good news is that a close examination of infrastructure can reinforce strategic investment objectives and deepen the investment dialog with your clients.
In terms of access, infrastructure ETFs, mutual funds and public securities are the logical place to start. These vehicles will provide clients with an immediate and tangible basis to address the waves of information that will come the adviser’s way this year and into the foreseeable future. These investments will fit into existing portfolio frameworks, while facilitating the discussion around sector composition, top holdings, correlations to other equity and debt investments, as well as response to global events. Liquid, public strategies will have betas that are closely correlated to broader equities but will provide targeted exposure to owners and operators of infrastructure assets, as well as providers of materials and services that will be closely tied to infrastructure investments. Select strategies will also enable clients to express views on environmental, sustainability and governance (ESG) guidelines, which will continue to gain traction among global institutional and individual investors.
However, public securities will only provide select exposures to infrastructure as an asset class. Also, they will not address the key topic of liquidity that should be on the table for medium-term planning. Ultimately, it’s wise to push for a purposeful trade of liquidity to better access the diversification, income and inflation-protection benefits of infrastructure sectors. It will be important to evolve liquidity standards of individual portfolios at the appropriate pace and with a well-developed long-term investment thesis.
Institutional investors have broadly embraced infrastructure investments in traditional private equity structures. These structures provide global managers with the most flexible mandate to pursue a diverse set of long-lived global projects. The best managers utilize this flexibility to invest capital across infrastructure sectors in selected jurisdictions around the globe. Privately negotiated transactions provide the long-term, contractual terms that create the benefits discussed above for infrastructure investments. However, these offerings also require drawdown/capital call mechanisms and lockups that can extend 10 years or more. Most individual investors do not have the appetite for these structures at present. Even individual investors who are qualified and experienced with these terms, tend to focus on higher returning private equity strategies. This may change but we are still early in the adoption cycle for individual investors. The important takeaway here is to make sure clients do not dismiss infrastructure as an asset class due to concerns over these types of structures.
So, with limitations on exposures that daily liquidity structures can provide and restrictive qualifications, terms and liquidity provisions that are characteristic of private offerings, one can expect a steady increase in the number of semi-liquid infrastructure strategies in the U.S. market. This will include interval funds, which provide periodic liquidity with a notice period as well as tender offer strategies, which have mechanisms for periodic liquidity with certain conditions and contingencies. Quarterly liquidity will likely emerge as a standard for the semi-liquid market in infrastructure. This will be an attractive middle ground for individual investors, but let’s recognize that this is a compromise that has tradeoffs that need to be well understood.
It is important to know how the liquidity provisions for an infrastructure strategy are being achieved. This will rest on the balance of liquid, public and illiquid private holdings in the portfolio. The appropriate mix is a portfolio construction decision, but one that should be made purposely and with the validation of investment metrics that appropriately reflect the mix of public and private assets.
The advantages of semi-liquid structures will extend to ease of investment and client experience. Interval and tender offer funds are continually offered, eliminating the complexity of vintage timing that is found in private funds. They also carry lower qualifications, minimum investments and fee levels. The relative ease of tax reporting via 1099, instead of K-1, and cash management due to immediate investment, instead of capital call mechanisms make these structures much more palatable to investors who are new to private markets.
LAYING THE GROUNDWORK
It’s prudent for advisers and investors to spend time throughout the year to question how infrastructure will fit into their investment strategies for years to come. A checklist to prepare for future investment in infrastructure should include defining the asset class and its underlying sectors, setting expectations for risk and return attributes, developing an investment thesis that addresses benefits of diversification, income and inflation protection, and surveying available strategies and structures that will provide individual investors greater access to infrastructure opportunities.
Importantly, infrastructure investments can be utilized to achieve longstanding objectives and do not require a substantial reassessment of risk and return expectations. The asset class and its sectors fit into existing frameworks for portfolio construction with one notable exception, liquidity. This is why transparency, education and accessibility need to improve for individual investors. Infrastructure will require a greater commitment of time and capital than traditional public markets, and it will be incumbent on investors, advisers and managers to have the knowledge and analytics necessary to support these commitments.
Selecting the right manager will take time and a structured approach. Differentiators for leading managers include global reach, experience and track record by sector and local expertise in specific jurisdictions. Managers also need to be connected into strong networks that will provide access to projects. Global resources, consistent capital and expertise in sectors and local markets enable the best managers to find and structure transactions that mitigate numerous risks and add value over long project lifecycles. Infrastructure managers combine multiple disciplines, including the ability to underwrite, operate and divest projects to create long-term value. Another important attribute will be to identify managers who are ready and willing to meet individual investor needs, including ongoing education on infrastructure as an asset class.
As advisers and investors approach the decision of when and how to initiate or increase investments in infrastructure, it’s advisable to build a program that will provide diversified exposure to numerous sectors and geographies/jurisdictions. This approach will serve as a foundational element of your overall portfolio construction, providing total return opportunities with valuable sources of current income and structural protections against inflation and broader market volatility. You and your client will need to take the time necessary to address liquidity considerations and determine which vehicles and managers will help meet your total portfolio objectives.
Our global society must accelerate the pace of investment in essential infrastructure to address several threats, challenges and opportunities for progress. The need for infrastructure investment globally is immutable and will manifest in heightened interest among individual investors. Advisers need to prepare to counsel their clients on how to approach and evaluate infrastructure sectors and integrate these investments into a larger component for their long-term investment strategies.
Scott Reeder and Todd Slattery are managing directors at BlackRock.