Commitment to asset class strong despite tepid returns
Infrastructure managers, flush with capital from years of success on the fundraising trail expect lagging transactions volumes to pick up, but returns are another story.
Falling yields and the growing demand for infrastructure have resulted in lower average returns for infrastructure in recent years, industry insiders say.
While an investor might have been able to achieve a low double-digit return on a large infrastructure investment three or four years ago, "this is now more likely to be in the high single digits," said Lee Mellor, director in the London office of middle-market infrastructure management firm Ancala Partners LLP.
"Returns will vary based on asset, sector, geography and even the size of the transaction," Mr. Mellor said. "Given the current low-yield environment, investors are attracted to the yields that are available through infrastructure and hence there is now significant capital competing for certain assets."
Returns also vary widely by fund vintage year. The median net internal rate of return for an infrastructure fund closed in 2014 is 10.4%, down from 12% for 2010 vintage funds but up from 8% for 2012 vintage funds and 9.4% for 2013 funds, according to data from London-based alternative investment research firm Preqin.
But investors see more benefits to infrastructure investing than just the returns.
In May, the New Mexico State Investment Council, Santa Fe, committed $100 million to Macquarie Infrastructure Partners IV.
The $22.1 billion endowment has a 9% target allocation to real assets that includes infrastructure, timberland and agriculture. The role of real assets within the broader portfolio is to provide cash-flow and a hedge against inflation, said Paul Chapman, director of real estate and real assets, investment committee meeting minutes of the May meeting show. Mr. Chapman emphasized the large need for infrastructure development within the U.S. Some $401 million of the council's $1.1 billion real asset portfolio is invested in infrastructure, according to the meeting minutes.
Overall, the council has achieved a 12.5% net return for calendar year 2016, according to a report by real asset consultant Townsend Group for the council's June 27 meeting. Infrastructure along with energy were the leading contributors to that performance.
$149 billion waiting
Still, the number of infrastructure deals worldwide is declining. According to Preqin, there were only 277 deals announced in the second quarter, worth a combined $51 billion, the fewest transactions since the third quarter of 2009.
This is also a slowdown in terms of transaction values. There had been transactions valued at $100 billion or more each quarter from the third quarter of 2015 to the fourth quarter of 2016.
Even so, investors should keep their eyes on infrastructure, in part, due to the "impressive" amounts of capital infrastructure managers have raised, said Bill Stoffel, U.S. head of private equity at Ernst & Young LLP., New York.
Infrastructure managers worldwide have a combined $149 billion in dry powder, according to Preqin.
So far this year, 31 infrastructure funds have raised a combined $38 billion in capital, compared to 68 funds that raised a total of $63 billion in all of 2016, Preqin data show.
"Infrastructure has evolved from primary financing to actually adding business and operational improvements for infrastructure companies, parallel to the way private equity has evolved," said Peter Taylor, managing director and new co-head of the infrastructure business of The Carlyle Group, Washington.
At the same time, global infrastructure need, amounting to an estimated $3.3 trillion a year through 2030, is expected to propel additional investments, according to a 2016 report by McKinsey Global Institute.
"There's a lot of privatizations going on in the infrastructure world and more will happen in the U.S., at least under the current administration," said Jahn Brodwin, New York-based senior managing director in the real estate solutions practice at FTI Consulting Inc.
Ernst & Young's Mr. Stoffel agreed.
It is the hope and expectation that the Trump administration's interest in investing in infrastructure should help to propel private investment in infrastructure in the U.S., Mr. Stoffel said.
Typically, when a program is an administration priority, there are government subsidies to encourage private investment, Mr. Brodwin said.
Still, infrastructure as an asset class and private infrastructure investment as a way of financing infrastructure is in "early innings in the United States," said David Rogers, founding partner of private equity and infrastructure manager Caledon Capital Management, Toronto.
While he noted there is a push to increase public-private partnerships in the U.S., a big increase will not happen overnight. "I think it will take time," Mr. Rogers said.
Mr. Rogers said an increase in private investment in infrastructure in the U.S. is likely to start when officials in states and cities decide private infrastructure investment makes sense and turn to public-private partnerships to fund projects, he said.
Between 80% and 90% of U.S. infrastructure is owned at the state and municipal level, Carlyle's Mr. Taylor said.
"The White House has elevated the national conversation on additional approaches to solving the USA infrastructure need," Mr. Taylor said. "Clients are asking, `Are you positioned for this?' "
Carlyle executives expect an increase in infrastructure investment opportunities for other reasons, too.
Oil and gas industries continue to suffer "stress around how to fulfill their infrastructure needs," Mr. Taylor said.
Firms like Carlyle are investing in infrastructure to help bring the oil and gas to market.
Another opportunity will be in the power utility industry.
"Government, industry, education and hospitals are seeking alternatives to a traditional utility-led industry model especially focused on choice of generation, resiliency and cost parity," Mr. Taylor said.
Hospitals, for example, need a higher degree of what he calls "resiliency."
"They can't afford (a power) outage due to an ice storm or a hurricane," Mr. Taylor explained. "We are seeing increased demand for smarter and more cost effective solutions."
At the same time, consumers in the U.S. do not want to pay for infrastructure projects such as roads and bridges that they already paid for, he said. People in the U.S. often balk at paying tolls on existing roads that had been privatized to defray the use of public funds for improvements and maintenance.
Because of this, "there is potential for 'asset renewal' whereby the government leases existing infrastructure to the private sector and builds significant new infrastructure from the proceeds," Mr. Taylor said.
These deals tend to include taxpayer protections, he asserted.
"At the end of the lease, the asset is greatly improved and it remains in the hands of the citizens," Mr. Taylor said.
Managers are continuing to expand the definition of what types of investments are included in the infrastructure asset class.
European and Australian managers have long considered investment in schools and jails to be a type of infrastructure, noted Caledon's Mr. Rogers.
The way investors access the assess class is evolving also, said Joshua Duitz, the Purchase, N.Y.-based portfolio manager of Alpine Woods Capital Investors LLC's Alpine Global Infrastructure Fund, which invests in publicly traded infrastructure companies.
Companies that can build the infrastructure project and then operate it have a competitive advantage, he said.
"It derisks the project if you build it yourself," Mr. Duitz said.