Investment activity in infrastructure was strong in 2017, but down on the previous year. However, 2018 is expected to see more capital pumped into the sector.
IPE Real Assets’ most recent survey found that institutional investors continue to be attracted to infrastructure.
Vincent Gerritsen a partner at Ancala Partners says over the past year a number of fundamental drivers have triggered significant infrastructure investment opportunities, including the “ongoing push for renewable energy and other energy efficiency solutions, large utility companies reshaping their portfolio, and exploration and production companies divesting their midstream assets to re-invest the proceeds into their core upstream businesses”.
The increasing demand for connectivity and data will drive development of supporting infrastructure such as fibre networks and telecom towers providing investment opportunities for infrastructure investors, Gerritsen says.
“There is an increasing need for new or upgraded transportation infrastructure to support economic growth,” he says. ”A number of European countries have initiated an active PPP programme to develop new transportation infrastructure projects such as Norway, Germany, Netherlands and Spain.
“This provides opportunities in both the primary market but also in the secondary market as construction companies are recycling interests in operational projects to free up capital to participate in primary projects.”
Looking ahead, these strong and sustainable drivers will continue to fuel a healthy supply of investment opportunities, Gerritsen says.
Jay Yoder, a managing director at Pavilion Alternatives Group believes that, in 2018, “investors should be concerned about the flood of capital into private infrastructure”.
Yoder says that, given the high level of capital secured by infrastructure funds recently, it is no surprise that dry powder recently stood at a record $149bn. “Not coincidentally, competition for assets has also been growing,” he says.
More than half (55%) of infrastructure firms report that there is now more competition than 12 months ago (the other 45% are apparently not paying attention, Yoder says). Furthermore, the largest institutional investors are increasing their direct investment activity and, more often, are competing with infrastructure funds for assets.
”As one would expect, this increased competition has led to high and rising valuations, which is the biggest issue facing the asset class today,” Yoder says
In November, Oslo Pensjonsforsikring (OPF), Norway’s largest independent municipal pension fund, reported that it had generated a 26.5% return on its infrastructure investments in the first nine months of the year.
One the most common observations in the infrastructure market today is how expensive the asset class has become, as ever-greater volumes of capital continue to flow in. But OPF’s high double-digit return shows the other side of the coin: early-movers are reaping the rewards.
Chief executive Åmund Lunde told IPE Real Assets that “an important reason” for the high returns was “that some of the funds we have invested in are maturing, and selling their assets at higher prices than expected”.
According to data provider Preqin, infrastructure deals during the third quarter of 2017 rose, following a slowdown at the half year stage of the year, but remains some way below levels seen in 2016.
There were 365 announced infrastructure deals during the period worth $88bn (€74.7bn) in total, and Preqin said it expects these totals to rise by around 5% as more information becomes available. The figure already surpasses the $55bn in deal value seen in second quarter of the year, reversing the slowdown seen through the first half of the year.
”While aggregate deal values have rebounded, the number of deals announced has continued to fall, failing to match the 414 deals seen the previous quarter,” Preqin says.
As a whole, 2017 has so far marked a significant slowdown compared to 2016: in the first three quarters of last year, 1,753 deals were announced worth a combined $335bn, compared to 1,282 deals worth $231bn during the same period in 2017.
Preqin says renewable energy assets have continued to attract the most attention in the first three quarters of 2017. “They account for 57% of the number of deals announced so far through the year, up from 47% in 2016,” it said.
Yoder says when it comes to renewable energy, “because of the many investors who wish to invest in renewable energy for social, environmental, and political reasons, the single-digit returns available today from investments in this sector will, by definition, be lower than their risk profile would otherwise dictate”.
According to IPE Real Assets’ top 100 ranking of the world’s largest infrastructure investors – capturing $360bn of investments in aggregate – the average allocation to infrastructure is about 3%.
Commenting on the global listed infrastructure outlook, Vince Childers, portfolio manager at Cohen & Steers Real Assets Fund, says stronger global growth is already benefiting the more economically sensitive infrastructure subsectors. “For example, many infrastructure subsectors have contracted cash flows that are directly tied to inflation, such as annual rate escalators linked to published inflation measures,” he says.
Higher oil and gas prices should also particularly benefit midstream energy companies, as increased energy production in North America is likely to drive expectations of higher pipeline volumes, he says, but adds that rising interest rates could pose a near-term risk to infrastructure performance.
However, history shows that after a negative reaction to significant increases in Treasury yields, infrastructure has generally outperformed global equities over ensuing months as the benefits of stronger economic growth are felt, Childers says.
“Over the long run, we expect infrastructure companies will continue to benefit from the massive need for private financing to help cash-strapped governments fund critical infrastructure improvements after decades of underinvestment.”
The US is experiencing similar infrastructure investment themes as the rest of the developed world – specifically, the lower-for-longer interest-rate environment is driving demand for yield and spurring higher valuation multiples across various industries, says Dylan Foo, head of Americas infrastructure at AMP Capital.
Large “trophy” deals and core infrastructure assets continue to be priced at a challenging risk-return equation, with no margin for error, partially driven by competition from large pension funds with low cost capital, he says.
Examples of these types of transactions in the infrastructure sector are toll roads, which have recently traded at more than 30 EBITDA multiples, and regulated assets, such as utilities, which trade at around 8%. Given current market conditions, large, core infrastructure trades in the 7-9% range.
“As the US Federal Reserve continues its slow path of interest rate increases, these trends will continue into 2018,” Foo adds.
AMP Capital seeks to “invest in assets with value-add opportunities with full control over governance, whereby we can expand on our base case via active asset management”, Foo says.
The sectors AMP Capital focuses on are energy, transportation, social and communications infrastructure, as these “core-plus” sectors provide the best risk-return equation in the infrastructure market,” he says.
“Looking ahead to 2018, AMP Capital believes there are significant opportunities and growth in rail related infrastructure, battery storage and communications.”
Despite concerns over asset valuations, investors remain positive and committed to the infrastructure asset class, trusting in its ability to hedge against inflation, and deliver strong risk-adjusted returns and stable cashflows in a low interest-rate environment, says Tom Carr, head of real assets products at Preqin.
“They are well-served by funds seeking to secure their capital, with a record $130bn currently being targeted by funds on the road. Given strong fund supply and robust investor demand, 2018 already looks as though it could be another bumper year for the infrastructure industry.”