Infrastructure managers try to stand out in crowd

Infrastructure managers are fashioning specialized investment strategies they hope will provide investors with higher returns in what has become a competitive playing field.

Even though fundraising for infrastructure funds worldwide appears to be slowing from the record $85 billion raised in 2018, Preqin data show, there's still plenty of available capital. Some 19 infrastructure funds globally raised $8.4 billion in the quarter ended Sept. 30, down from the record $44 billion raised in the third quarter of 2018.

Moreover, in recent years, private equity firms such as The Blackstone Group Inc., Apollo Global Management Inc. and Carlyle Group LP are expanding into infrastructure. In July, Blackstone Group closed its first open-end infrastructure fund with $14 billion.

All of this capital, in turn, is driving up prices.

"There's plenty of equity coming into infrastruct- ure," said Juan Angoitia-Grijalba, Madrid-based senior managing director, Ardian Infrastructure, a unit of private equity manager Ardian. The manager's infrastructure team had $16 billion under management or advisement as of mid-July.

Past returns, as well as the stage of the economic cycle, is fueling the interest, industry sources said.

Overall, infrastructure has produced double-digit returns over most time periods, according to Preqin data. For periods ended Dec. 31, 2018, infrastructure produced a 12.8% internal rate of return over one year, 14.3% over three years, 11.8% over five years and 8.7% over 10 years.

Today, investors are most interested in investments with stable, predictable cash flows that are less risky than other investments as the economic recovery enters its twilight years. To do this, managers are taking more risk, focusing on returns rather than steady cash flow, industry insiders say.

"It's the part of the cycle where there are difficulties ahead of you," Mr. Angoitia-Grijalba said.

Infrastructure fits the investment profile and is quite resilient, he said.

In March, Ardian closed its latest infrastructure fund, Ardian Infrastructure Fund V, at its hard cap of €6.1 billion ($6.7 billion) after only four months of fundraising, Mr. Angoitia-Grijalba said.

"The fund was oversubscribed because performance was very, very good (in prior funds) and there is plenty of demand for the product," he said.

Infrastructure can be defensive or aggressive, he said. "It depends on the type of asset," Mr. Angoitia-Grijalba said. Some existing infrastructure projects are more like bonds in that they provide steady income. "Those types of assets are not for us," he added.

Ardian executives prefer to invest in projects where they can add value and earn higher returns than mature assets.

Ardian will invest in both new construction as well as existing projects that need improvements in energy, including renewable energy, oil and gas, midstream, cell towers and other telecommunications assets and sea ports, Mr. Angoitia-Grijalba said.

He said Ardian executives are not concerned that the amount of capital will overwhelm the opportunity set for infrastructure. "There is plenty of infrastructure to be developed in Europe and the Americas, we believe," Mr. Angoitia-Grijalba said.

However, he acknowledged there is also plenty of competition, which pushes up prices.

"Even for the assets we invest in, you have to be smarter and find a different angle," Mr. Angoitia-Grijalba said.

Competition is part of the game, he said. "Compared to a few years ago, there is more liquidity, more players and more competition."

First State Investments LLC is dealing with the increased competition by focusing on the middle-market transactions, not larger deals, said John Ma, director of the New York infrastructure team.

In the past 10 years, the availability of transportation assets in North America has become more constrained than in other jurisdictions. Large-scale asset privatizations in the U.S. have not materialized, Mr. Ma said. Transportation assets are attractive investments because while they are sensitive to the ups and downs of the economy, they can produce higher returns than a lower risk energy utility, Mr. Ma said.

"Airports are the holy grail," said Danny Latham, Sydney-based partner of First State Investments. The manager has owned airports since 1997, which have been the best-performing assets over the last 20 years, Mr. Latham said.

"It's hard to wrestle airports out of municipal hands," in the U.S., Mr. Lathan said.

In August, First State Investments acquired Patriot Rail and Ports, which operates 12 U.S. short-line freight railroads from SteelRiver Infrastructure Partners. Ownership of the short-line freight rail business is fragmented and in private hands, Mr. Ma said.

There is a bit of a tailwind for railroads because rail is a more efficient way to move products to market than trucking in the U.S., Mr. Ma said.

Patriot represents the initial unlisted infrastructure investment in the U.S. by FSI, which manages more than $8 billion of unlisted infrastructure investments across the United Kingdom, continental Europe, Australia, New Zealand and North America, with a focus on midmarket companies in the transportation and utility sectors worldwide. It also manages $8 billion in listed infrastructure.

In the U.S., First State Investments executives are not just interested in investing in transportation assets, he said. They are also looking at other sectors especially in water, wastewater, renewable energy, shale gas and transportation.

The firm also is expanding into different sectors across the globe, including water and moving wastewater from energy operations.

Potable water infrastructure in Australia and the U.S. are still owned by the government and is more political, Mr. Latham said. Wastewater is less political, he said. Among wastewater opportunities are using recycled water to flush toilets and water lawns, he said.

Capital Dynamics focuses on a narrow niche of renewable energy infrastructure, said John Breckenridge, a New York-based senior managing director and head of energy infrastructure. As of June 30, Capital Dynamics' AUM for its clean energy infrastructure unit was $6.3 billion.

"Renewable energy infrastructure is the largest infrastructure sector by number of transactions, is the fastest growing and is the most interesting," Mr. Breckenridge said.

"There's a tremendous amount of innovation around renewable energy infrastructure," he said. "It's attracting a lot of capital, for sure."

There are a number of new managers entering into infrastructure, broadly, and into renewable energy infrastructure, specifically, Mr. Breckenridge said. The reason is investor demand.

"The investment appetite for renewables has exploded over the last several years," he said. "Five years ago, we talked about ESG and investors cringed a little bit. … Now ESG is the first thing (investors) ask about."

Today, there are three categories of renewable energy infrastructure projects, Mr. Breckenridge said.

The first are low-risk, large, operational assets with 25-year contracts to sell energy. Returns on those are falling, Mr. Breckenridge said. The second type are projects with exposure to the Texas merchant power market. Many of these are projects that use a hedge counterparty, giving the investor a fixed price for power for 10 years. Investors typically use the 10-year locked-in prices for power to add leverage. Much of the cash flow is used to pay off the debt, he said.

"This is a huge risk," Mr. Breckenridge said. At the end of the decade, the investor will have a mostly unlevered project exposed to highly volatile Texas power prices. Investors will likely get their money back on their investment if solar projects were not overbuilt and prices are high.

"There is a very low chance of that," he said.

The third type are smaller projects, such as installing solar panels on roofs of a city's buildings, that have to be operated very efficiently.

"You need to be a specialist. These are more complicated ... and higher returns," Mr. Breckenridge said. "It's a huge market right now."

Today, municipalities and large corporations are looking into the next stage of buying renewable energy, he said. They are installing renewable energy plants on municipal buildings and garages.