Despite the rising infrastructure asset prices, 2017 was a "pretty good year for infrastructure, not spectacular, but pretty good," said Ted Brooks, Plymouth Meeting, Pa.-based portfolio manager, global listed infrastructure, at real asset manager CenterSquare Investment Management. The firm has a $27 million seed portfolio investing in listed infrastructure.
Infrastructure funds have earned a median internal rates of returns averaging 10% in the funds raised in 2004 to 2014, Preqin data shows. Moreover, infrastructure is the best performing of all the 2014 private capital funds tracked by Preqin, which are the most recent vintage returns provided by Preqin. Newer funds are too early in their lifespans.
"The rebound in global crude prices affects a huge swath of infrastructure that invests in energy,'' Mr. Brooks said, while the inflationary environment has been benign.
"By the nature of its composition, infrastructure is a balanced asset class. Half of the universe is utilities, which are pretty defensive because they are monopolistic businesses."
Brent Burnett, Portland, Ore.-based managing director of real assets at consultant and money manager Hamilton Lane Inc., said in an email that investors view infrastructure as defensive relative to other alternative asset classes.
"We are seeing more institutions begin to position their portfolios defensively — which includes increasing allocations to infrastructure," Mr. Burnett said. "Infrastructure investments are certainly not without risk, especially given pricing today for some core assets, but institutional investors … will continue to view infrastructure as attractive relative to other alternative investments."
Hamilton Lane executives expect to see new infrastructure managers as private equity firms start offering infrastructure funds, making "an already crowded space even more crowded," Mr. Burnett said. "It remains to be seen whether there is sufficient investor demand for these new product launches on top of established firms coming back to market" with new infrastructure funds.
The high price of core infrastructure is causing some managers to great creative, expanding the definition of infrastructure, Mr. Burnett said.
"We've seen investments in infrastructure funds that have included data centers, crematoria, outpatient care facilities, laundromats and even home water heaters," Mr. Burnett noted. "These are a far cry from airports and power plants, but given competition for traditional infrastructure assets, managers are looking to acquire assets or companies with infrastructure-like characteristics, including contracted revenues and high barriers to entry, without paying core infrastructure prices."
While this often increases risk, these managers believe that the risk is mitigated by lower prices and the managers' greater ability to increase the investments' value through operational improvements, he explained.
Expected interest rate increases are another factor that could add risk to infrastructure portfolios are as governments around the world unwind the quantitative easing, infrastructure managers say.
In the past eight years, low interest rates had driven some investors to increase real asset allocations in their search for yield, said Ross Israel, head of global infrastructure in the Brisbane office of money manager QIC Ltd. Higher interest rates will raise the cost of capital, cutting into returns, he said. Too much debt could eat away at equity returns, he added.
The rising cost amplifies importance of diversifying investments across multiple markets, he said.
Infrastructure general partners can also manage interest rate risks through active management of capital structures including staggering debt maturities, refinancing at more attractive rates and foreign exchange and interest rate hedging strategies, Mr. Israel said.
"Hedging is something we would look to focus on because of where we are at this point in the cycle," he said.
Ben Morton, senior vice president and portfolio manager for listed real asset manager Cohen & Steers Inc., New York, said in an email that higher interest rates are likely to challenge investments in the generation and transmission of electricity.
"We believe utilities face significant challenges due to their heightened sensitivity to rising interest rates, as well as regulatory and political intervention," Mr. Morton said.
However, Julio Garcia, head of infrastructure, North America, at infrastructure manager IFM Investors Pty. Ltd., in New York, notes that investors should remain aware that infrastructure investments in renewable energy are not without risk. "They should consider what happens when the contract ends."
For example, investments in renewable energy are based on the price of electricity. Once the contract between the wind or solar energy provider and the utility buyer ends, it is very difficult to predict the future price of electricity, Mr. Garcia said. That is especially the case these days when consumers and business are more conscious about energy conservation, he added.
QIC's Mr. Israel said the world is entering a period of change in the energy value chain. "We are transitioning away from carbon fuels. This brings challenges and opportunities."n