As infrastructure matures, fuss on style drift grows

Infrastructure is coming of age as an institutional asset class — a process that's not without growing pains, market veterans say.

The asset class continues to see a pickup in interest on the back of relatively strong returns.

The benchmark index for global unlisted infrastructure equity assets launched June 7 by Singapore-based EDHEC Infrastructure Institute showed returns for the year through March 31, including leverage, of 11.6%, slipping from annualized three-year returns of 12.6% and five-year returns of 14.1%.

But the definition of infrastructure has evolved a lot in recent years, raising concerns among some asset owners.

Isabelle Demir, head of real assets with Melbourne-based investment consultant Frontier Advisors Pty. Ltd., said one school of thought now maintains that, with core infrastructure looking very expensive, some managers are going into sectors that fit more naturally under the banner of private equity than infrastructure.

That blurring of the lines has come as the biggest asset owners are increasingly fielding dedicated teams to manage their allocations to infrastructure.

For large limited partners over the past five years — including sovereign wealth funds and big pension funds — infrastructure has graduated from being an "orphan," situated somewhere within real assets or private equity, to a "very established asset class" in its own right, said Kevin Lu, Singapore-based partner and chairman, Asia, with Partners Group AG, a Baar, Switzerland-based private markets manager with roughly $10 billion in infrastructure assets.

According to EDHECinfra, the market capitalization of its global unlisted infrastructure equity benchmark came to $348.4 billion as of March 31 — for a representative selection of 500 private infrastructure companies or vehicles out of a broader universe of 5,000.

Even so, compared to other asset classes, infrastructure investments continue to offer "a very broad range of return and risk," from steady, bond-like investments to more private equity-like returns, said Mr. Lu.

Danny Latham, a Sydney-based partner, infrastructure investments, with Colonial First State Global Asset Management - known outside of Australia as First State Investments - expressed sympathy with those concerned that the market now is seeing some of the same style drift that preceded the global financial crisis of a decade ago.

Whether it's the definition of infrastructure or a question of leverage, some people have been left saying "here we go again," he said.

Others, however, note that some of that style drift simply reflects changes in underlying infrastructure markets now.

"The definition of infrastructure is evolving," and — to the extent that reflects pressure on returns pushing people into new areas — that's making investors "very nervous," said Ross Israel, head of Brisbane-based Queensland Investment Corp. Ltd.'s A$11.3 billion ($7.8 billion) global infrastructure business. But "investors need to be somewhat careful … because some underlying (infrastructure) sectors are evolving, in terms of the way they've traditionally operated," offering up new opportunities which could falsely be interpreted as style drift, he said.

Meanwhile, for some of the newer thematic infrastructure trends, especially technology-related ones, a "very different skill set, different specialist knowledge is required," noted Dania Zinurova, Sydney-based director of manager research, Australia, with Willis Towers Watson PLC. New, focused boutiques have emerged in the space, but even well-established managers began adding specialists with the requisite backgrounds to their teams last year, and "this year it's even more so," she said.

At the same time, the targets for infrastructure investment are expanding, and the taxonomy of their risk profiles is being delineated more finely.

"Infrastructure is getting more mature," resulting in a greater segregation of risk pools, said Neil Johnson, a Hong Kong-based managing director and head of infrastructure, China, with Macquarie Infrastructure and Real Assets. MIRA oversees roughly A$178 billion in infrastructure assets through public and private funds, co-investments, partnerships and separately managed accounts.

Mr. Johnson noted that MIRA took the lead two or three years ago in offering a "super core" strategy composed of "regulated, very stable, long-term utility-like businesses," leaving room for core and core-plus at the higher end of the risk spectrum.

With continued "stretching (of) the boundaries of infrastructure (and) taking on more risk" there could be offerings going forward that eventually fall under the "core-plus-plus" heading, Mr. Johnson said. He said that greater segregation of risk will be in the interests of investors.

Mr. Latham said his firm's view of infrastructure — as, generally, assets with high barriers to entry, a high fixed asset base and stable, predictable revenue profiles — fits with investors seeking high cash yield, bond-plus, defensive strategies to help match assets and liabilities.

Demand for First State Investments' "vanilla" brownfield developed market-focused strategies remains strong, and if yields are under pressure now the firm will "take a little bit more risk in sectors and geographies that we know well, instead of heading off into new areas," said Mr. Latham. By way of example, he cited the planned buildout of a new $1.4 billion runway at Brisbane Airport, in which First State Investments owns a 26% stake.

The invested and committed capital across First State Investments' various infrastructure strategies now comes to roughly $15 billion.

Rather than seek out new sectors to invest in, "one area that we're becoming a little more segmented by is around size," said Mr. Latham. With leading infrastructure managers now raising funds between $15 billion and $20 billion, and big asset owners like the Canadian pension funds doing direct deals, "in our view, the large-cap end of the market is becoming pretty hot," he said.

With "an increasing number of elephant hunters but less elephants," Colonial First State is focusing more now on the midmarket space, where — on a long-term hold basis — better value to the tune of 100 to 200 basis points can be had, said Mr. Latham.

Mr. Johnson said one of MIRA's newer business models now, particularly in Asia, focuses on "industrial infrastructure," with big corporations as counterparties rather than governments.

An example is the water sector in China. "Historically, we've invested in municipal water and today, for those high-quality government off-take assets, they're very stable," he said, noting that the sector's relatively low risk has left target returns typically falling short of what MIRA is seeking for its Asia fund.

"So now we're increasingly looking at industrial water, where it's a business-to-business model," he said. "We're getting paid directly by those industrial end users … taking on more risk but confident in doing so because of our five years of operational experience in China's municipal sector," he said. And in line with those higher risks, MIRA is garnering higher returns, he said.

That increased focus on business-to-business deals, which other managers say they're pursuing as well, doesn't mean governments — the prime movers globally in the build out of infrastructure assets — are becoming any less crucial for infrastructure managers.

In what he termed a "sea change" over the past two years, Mr. Lu said Partners Group today is "talking to government much more than before."

In the past, Partners Group would reach out to government officials for information relevant to specific infrastructure deals, but that has given way to a systematic effort to talk to "relevant government agencies in the countries we want to operate in," to understand what they're looking to do and how foreign private capital could play a role, said Mr. Lu.