Investing in private infrastructure: A look at insights, trends and expert perspectives
Executive summary:
- More institutional investors are exploring infrastructure for diversification, income and stable return potential as well as inflation protection.
- Investors are looking at both the traditional segments and newer digital sectors along with renewables.
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On Nov. 15, Howard Moore, associate editor of custom content at Pensions & Investments, moderated an online discussion on infrastructure as an asset class and its potential as a valuable addition to a multi-asset portfolio.
Joining Moore were panelists Michael Steingold, CFA, director, private markets at Russell Investments, participating from London, and William Smales, partner and chief investment officer at Morrison & Co., participating from New York.
Steingold leads Russell Investments’ research of unlisted infrastructure strategies and is the portfolio manager of the Russell Investments Global Unlisted Infrastructure Fund. He also serves as portfolio manager for select client portfolios investing in infrastructure, real estate and private debt and has worked on consulting projects in private markets for large government, industry and corporate pension clients. During the webinar, Steingold explored the macro trends shaping the infrastructure landscape, and how these trends are impacting investment opportunities.
Smales shared his expertise, insights, and valuable perspectives on digital sector investments, renewables in the global context, as well as opportunities beyond renewable energy generation.
Following are some highlights of their one-hour conversation. Periodic timestamps and indications of visual slides are provided.
Moore: How should investors define infrastructure and what key portfolio objectives does it help meet? <2:04>
Steingold started off by explaining that Russell Investments looks at infrastructure across six sectors, including growth areas such as renewable energy, digital and social, and more traditional areas, such as utilities, transportation, and energy.
“When we evaluate an infrastructure asset, we're looking for an underlying business which generates what we think of as privileged revenue for delivering an essential service to communities or to corporates,” he said. These businesses tend to have high recurring revenue and they tend to have strong linkages to inflation that can be via contracts or regulators or oligopolistic market structure.
“We believe these characteristics ultimately give us and our clients the best chance of achieving the risk/return and the inflation sensitive profile that investors seek to get out of infrastructure,” Steingold added.
Asset owners have tended to underweight infrastructure in their overall portfolios. Has that shifted in recent years, and why? <5:20>
Steingold explained the asset class, until only recently, was accessible only to the largest institutions due to a combination of high minimum investment amounts and long illiquidity of closed-end funds.
“The investable infrastructure universe in the U.S. relative to other global regions has also been small so you needed to be a very large institution to access infrastructure globally. What was available in the U.S. was relatively limited and that has to do with the efficiency of the muni bond market as a funding mechanism for infrastructure in the U.S. and what you could invest in was really dominated by the energy sector.
Today, however, he explained, with product innovation and growing needs among communities and other corporates for infrastructure, the asset class has become more accessible. “We're seeing institutions of all sizes either increase allocations where they had them before or establish them where they didn't previously exist,” he said.
“In recent years, we've seen those allocations being funded from fixed income. When rates were very low, we were seeing a move from fixed income into infrastructure, looking for that stable income. Today, it's much more likely to see that allocation being funded by real estate.”
Increasingly, asset owners seem to be making infrastructure part of a core multi-asset portfolio rather than a satellite allocation within a multi-asset portfolio. What are you seeing? <9:04>
While showing the slide, Unlisted infrastructure in multi-asset portfolios, Steingold explained that in a multi-asset portfolio, the asset class profile of infrastructure is very useful—it complements stocks, bonds, other alternative assets such as private real estate, and even listed infrastructure.
“It’s clear that the exposures you get in unlisted infrastructure—especially to growth themes like renewables, digital and social assets—are simply not available in the same way on the listed market. The asset class also provides a reliable source of inflation protection. This has always been the theory of infrastructure investment—that it would protect against inflation. That theory was finally tested in a meaningful way in recent months as we have had our inflation spike episode. We have seen how well infrastructure has been able to capture this inflation, unlike basically every other asset class. There are few financial assets which have this inflation sensitivity feature. We’re seeing the attractiveness of the asset class increase among more and more investors who want that type of protection in their portfolios, from institutions with inflation-linked obligations to family offices concerned about preserving purchasing power to increasingly wealth channels looking for a first entry into private markets,” he said.
Steingold further explained that exposures in unlisted infrastructure (especially to growth themes like renewables, digital and social assets) are simply not available in the same way on the listed market.
“The asset class also provides a reliable source of inflation protection. This has always been the theory of infrastructure investment—that it would protect against inflation. That theory was finally tested in a meaningful way in recent months as we have had our inflation spike episode.
“We have seen how well infrastructure has been able to capture this inflation, unlike basically every other asset class. There are few financial assets which have this inflation sensitivity feature. We’re seeing the attractiveness of the asset class increase among more and more investors who want that type of protection in their portfolios, from institutions with inflation-linked obligations to family offices concerned about preserving purchasing power to, increasingly, wealth channels looking for a first entry into private markets.”
Staying with the theme of returns, relative performance of infrastructure and—along with the broader macro-economic environment—could you speak to the relative performance of infrastructure in recent years? <12:50>
Steingold shared the slide Unlisted infrastructure in multi-asset portfolios, saying, “On the risk side, the relative performance has also been quite good.”
“Measures such as rolling volatility and max drawdown compare favorably to other asset classes, even when we zoom out and control for the slower-moving nature of unlisted asset valuations. We think this risk outcome is because of a combination of both the downside protection in the underlying assets and businesses—assuming your investment selection is done well—and the low interest rate duration in valuations, due to the inflation sensitivity of cash flows offsetting increases in discount rates. This is often counterintuitive for investors, but it’s a key attraction of the asset class,” he said.
What are your thoughts about this being an opportune time to be investing in infrastructure? <32:11>
Steingold shared the slide Secular trends underpinning the infrastructure opportunity.
“The performance of the past 18 months has been proof positive of the benefit of the asset class, and at the same time the entry point has become more attractive as discount rates have widened, the policy backdrop has become more supportive, and the accessibility has increased as many institutions have had to pause their private assets investment due to denominator effect and other considerations. For investors establishing an allocation, now is a great time to get capital to work quickly into the themes we are discussing,” he said.
Back to social infrastructure. Could you tell us just what that is—just to get our arms around it—and what the opportunity is for investors there specifically? <44:05>
Social infrastructure refers to community facilities like courthouses, fire stations, police stations, schools, and institutional facilities like universities and hospitals, Steingold explained.
“When we invest in the social sector, we are providing a solution that combines capital and the expertise needed to build or renovate and then maintain these facilities. Today, municipal governments and institutions need this solution more than ever. These facilities are more expensive to build following construction cost inflation and higher interest rates, and they are also more complicated owing to increased technology needs and desires for sustainability.
“On that point, we’re seeing great opportunities to provide decarbonization solutions for institutions for their net zero objectives—for example, by upgrading the physical plants in hospitals and by installing energy-efficient fixtures and microgrids on university campuses. These investments earn a low double-digit cost of capital while having great credit profiles and terrific ESG outcomes.”
Let’s turn to investing strategies in private infrastructure. Does Russell Investments offer access to both listed and private infrastructure? <49:03>
“We do,” Steingold said. “We find that listed and unlisted infrastructure are highly complementary in investor portfolios.”
He shared the slide Unlisted infrastructure is an access point to growth strategies, and further explained: “Listed infrastructure offers a low-cost access point to some very large, established infrastructure companies which have cost of capital advantages in their respective sectors. At the same time, these companies tend to be in the lower-growth part of the infrastructure universe, in what we call super-core and core risk profiles—businesses like regulated utilities, class 1 railroads, and yield-oriented portfolios of mobile towers and midstream energy assets.
“Unlisted infrastructure extends this universe to include the higher growth strategies of core-plus and value-add, where we find assets which can have the attractive risk characteristics of infrastructure while offering long-term growth potential from strategies like platform expansion, transformational capital-expenditure projects and targeted construction risk.
“We also find better access in the unlisted market to the key sectors of renewables, digital, and social. Although these sectors are present in the listed market, we find the unlisted market offers the ability to get more granular exposure to the specific business models we prefer. Taken together, we find that investors do best in infrastructure when they combine both the listed and unlisted exposures.”
Smales also touched on private infrastructure.
“Morrison offers three global investment strategies: core/core+, value-add and listed infrastructure, and we execute on these strategies via a globally coordinated, one-team model. Remember, we are a long-term thematic investor, and these themes are global in nature and consistent across all three of these strategies,” Smales said.
What deal structures are important for investors to understand from your perspective? <55:22>
Steingold said: “For a fund portfolio, important considerations are liquidity and need for diversification. Historically, infrastructure has been accessible only to the biggest institutions which could take multi-decade illiquidity. Because of product innovation with the rise of open-end funds in recent years, we find that unlisted infrastructure can increasingly be treated as just incrementally less liquid than a listed portfolio.
“These funds allow investors to access the market and get liquidity in three to six months in normal market environments, rather than taking on the extreme illiquidity of the 15+ year closed-end funds. This is especially useful for certain institutions—like pension funds which have de-risking or buy-out on the horizon—and the wealth channel, where investors can take a first step into private markets investing.
“Diversification is another critical consideration. Infrastructure assets are typically large and idiosyncratic, often with high political risk, which is difficult to predict. Investors need to diversify this risk by having a portfolio with a range of sectors, sub-sectors, technologies, regulators and so on. To do this, we find an appropriately diversified global portfolio will need upwards of around 100 assets. The challenge is that most infrastructure funds are concentrated in 10 or 12 assets, meaning investors need to have multiple funds in a portfolio or have a multi-manager solution. The extra work is worth it. We believe investors are more likely to harvest the benefits of this asset class when they are well diversified and can mitigate the risks of any individual investment.”
At this point, Moore wrapped up and asked each panelist to offer a key takeaway for 2024. <57:55>
Smales said: “We are always faced with an uncertain world environment, which is why infrastructure assets are particularly attractive as they are critical to the proper functioning of society under almost any scenario. Short-term market dislocation and concern around inflation and interest rates provides an opportunity in the market for those who can allocate to illiquids, to acquire scarce assets at attractive valuations.
Steingold offered these concluding remarks: “The positive performance of infrastructure in the recent environment of elevated inflation and rising interest rates has cemented the value of the asset class in multi-asset portfolios. At the same time, the growth opportunities available from the energy transition, the digital transformation and the need for upgrades to social assets are accessible to more types of investors than ever, thanks to new semi-liquid structures. We see 2024 as a year of opportunity for institutions to increase strategic allocations in an attractive environment and for wealth channels to bring this useful asset class to their clients.”