Publications

- October 1, 2019: Vol. 6, Number 9

A record year of investment: Private infrastructure investors shift to riskier strategies

by

Investor sentiment for infrastructure equity is at record highs. This appetite from infrastructure investors is reflected in the $89.5 billion of funds raised in 2018, exceeding the previous fundraising record of $73.4 billion set in 2017. Transaction volumes in 2018 were slightly lower than 2017 with energy continuing to be the largest subsector. However, there was a notable increase in telecommunication transactions from 5 percent in 2017 to 35 percent in 2018.

The increased capital flowing into the infrastructure sector is causing a shift in investment style to more noncore strategies, with almost 50 percent of funds launched in 2018 and 2019 targeting a value-add strategy. Core strategies tend to be more income-focused while value- add and opportunistic strategies rely more on capital growth to meet total returns. The move from noncore strategies shows that over the past five years the capital component of total returns makes up around 65 percent of total returns.

Gross absolute returns for the 12 months ending September 2018 contracted to 11.8 percent from 13.1 percent over the same period in 2017. The transportation sector delivered 14.9 percent in 2018, up from 13.7 percent in 2017, while returns from power assets fell from 13.3 percent in 2017 to 10.2 percent in 2018.

In addition to the shift to riskier strategies, the inflows into private markets have also resulted in valuations that are high by historical standards. The low-yield environment has contributed to the attractiveness of private markets with investors seeking to capture the premium private markets can offer.

The increased interest in the asset class has led to return compression; however, relative to risk-free rates, which have also been falling, infrastructure continues to provide an attractive premium. Additionally, the market is four times larger than 2007 with many new market participants and an increased understanding of the resilience of the asset class through economic cycles, which may mean that valuations have further to run.

Infrastructure debt is increasingly becoming an important part of investors’ allocation. However, it is worth noting that bank financing still makes up between 80 percent and 90 percent of total financing in the infrastructure market. Globally, nine senior infrastructure debt funds launched over the past two years and cumulatively raised $3.35 billion, which is small relative to the overall size of the global financing market. Coinciding with the correction in equity markets, there was also a repricing in public debt markets. This was more pronounced in the high-yield market, reflecting caution over economic growth, the tapering of government bond-buying programs and worries around the ability of companies to withstand rising rates.

Most infrastructure investors target an illiquidity premium over equivalent corporate bonds; therefore, the private market will need to adjust. The structure of the private market means that any repricing in the private market will typically lag any public market correction.

 

This article is excerpted from the UBS report titled Infrastructure Outlook: Top trends in 2019. Download and read the full report at this link: https://bit.ly/2zBDbe4.

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