Infrastructure has seen a large inflow of investor capital as central bank policy boosts liquidity and investors hunt for yield in low/zero interest rate environments. In contrast, the supply of infrastructure assets has remained subdued compared to historic levels. An ever wider group of financial investors has started to recognize the attractive features of infrastructure investing and prices for assets have risen. The impact of this is amplified by the fact that substantially all of the capital allocated to the sector is focused on investing in a small sub-set of the asset class – core, brownfield (operating) assets in stable developed economies. We call this the “crowded core”, where the large amount of capital chasing relatively few deals is driving up valuations.
Avoiding this “crowded core” is key to finding value in infrastructure.
Our strategy aims to avoid the crowded core by targeting managers through a mix of primaries, secondaries and co-investments that have proven, credible and differentiated strategies, and have industry connections or specializations that enable them to source deals directly without the need to compete in the very competitive auction processes. Through the secondary market, we believe there to be a particular opportunity to access infrastructure cash flows, of the same types attracting so much competitive attention in the primary direct market, in a much more advantageous supply and demand position. Broader real asset strategies offer further opportunity to find infrastructure like characteristics with potential for attractive risk adjusted returns.
Finding Value – Primary Fund and Co-Investments
Our approach to finding value in primary fund investments is to look for a complementary mix of generalist and sector/geographically-focused funds with core and core-plus strategies, sponsored by managers that in our view possess a proven, differentiated investment strategy. We look for evidence that managers have a track record of securing deals through bilateral processes over competitive auctions, can demonstrate an ability to navigate economic and commodity cycles, and take a prudent approach to leverage.
Co-investments that we make tend to be highly complementary to our primary fund investments. They can also bring the potential for J-curve mitigation, yield enhancement and cost-effective direct access. Strong GP relationships are crucial to developing an attractive co-investment dealflow. On a global basis, we have been favouring growth-oriented co-investments and defensive energy transactions.
Finding Value – Infrastructure Secondaries
We continue to believe that one of the best ways to find value in today’s frothy infrastructure market is to access infrastructure cashflows through secondaries. Our conviction is driven by:
- The rapidly expanding secondary market opportunity (our deal flow has increased from around US$1 billion in 2010 to around US$10 billion in 2015);
- A limited number of buyers creating a supply and demand imbalance leading to market inefficiencies and attractive pricing dynamics;
There have been relatively few new entrants into the infrastructure secondaries market. The buyer market is relatively shallow so combined with the increasing seller supply it is possible to be selective and seek out attractive risk adjusted returns.
Finding Value – Broader Real Assets
Over the last 18 months we have broadened our investment strategy to include other Real Asset sectors such as upstream energy, asset-backed strategies, timber and agriculture. This allows us wider scope to invest opportunistically across a broader range of asset classes to deliver portfolios with infrastructure-like characteristics of downside protection, cash yield and inflation protection whilst offering potential for more attractive risk adjusted returns.
Outside of Infrastructure our broader Real Assets investment strategy is underpinned by certain key themes, each of which we believe forms the backdrop for compelling investment opportunities across primaries, secondaries and co-investments. For example:
- Energy: Capitalizing on commodity price dislocation by targeting both mature, developed assets with low risk return profiles as well as early stage developing assets with private equity like characteristics. The dislocation in commodity prices has provided particularly attractive investment opportunities in developed assets both in the midstream and upstream space.
- Asset-Backed Strategies: Aiming to generate attractive cash-yield returns in a market that is inefficient and has financing shortfalls. Both the maritime and aviation industries are benefiting from strong growth fundamentals and providing exciting opportunities for private market investment. A specialist manager universe is quickly emerging for these types of investments.