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How infra ticks the box for LPs

Energy transition and digital infrastructure strategies have attracted new LPs into the asset class. The majority now plan to increase their allocations as sustainable investment becomes the norm…

Energy transition and digital infrastructure strategies have attracted new LPs into the asset class. The majority now plan to increase their allocations as sustainable investment becomes the norm…

The onset of the pandemic tested the infrastructure sector but ultimately demonstrated its resilience, resulting in increasing demand from investors. 

As they search for safe havens from inflation, there seems no sign of this slowing down. 

Up to 79%per cent of LPs plan to increase their allocation to infrastructure in 2022, with 30 per cent intending on keeping the same level of exposure to the asset class, according to recent sentiment surveys in the industry. 

“What we’ve seen is a slow and steady increase in allocations to infrastructure at an aggregate level. There are more investors allocating, but also more investors increasing their allocations,” comments Mercer partner, Amarik Ubhi. 

Two of the largest infrastructure funds closed this year include KKR’s Global Infrastructure Investors IV at USD17 billion, and Stonepeak’s Fund IV which closed at USD14 billion. Each showed strong interest from North American pension funds – a bedrock of the current market. 

According to news reports at closing, LP investors in KKR’s fund include pension funds New York State Common Retirement Fund, the Teachers’ Retirement System of the City of New York and the Minnesota State Board of Investment. Stonepeak’s fund featured over 150 LPs including the Washington State Retirement System, Oregon Public Employees Retirment System, New York State Common Retirement Fund and Teachers’ Retirement System of the State of Illinois. 

The asset class is continuing to steadily grow, with a projected CAGR of ~16 per cent between 2022 and 2026, according to Campbell Lutyens’ latest infrastructure market research. 

According to research from Global Infrastructure Hub, the current allocation to infrastructure is between 5 per cent and 12 per cent for Australia, between 8 per cent and 20 per cent for Canada, and Denmark’s PFA pension (which represent a typical EU or US pension fund) has an allocation of 1.5 per cent in infrastructure. 

In Australia and Canada and parts of Europe, public pension funds often invest directly in the asset class, or through an investment platform, but new entrants will often look first at the core part of the market. 

“Our European pension fund clients are more focused at the secure income end of the spectrum, meaning low risk, long-term, inflation-linked, contractual income for investors,” details Paul Jayasingha, head of real assets, WTW (previously Willis Towers Watson). 

Renewables and digital infrastructure also remain popular strategies, with the majority of LPs planning on deploying more capital to these strategies. 

While core assets such as roads and bridge remain popular investments, LPs are also deploying capital to newer areas, including early-stage tech ventures and operating companies, according to McKinsey’s 2022 private markets report. 

“Lots of investors are new to the asset class, so there’s still a spectrum between those making initial allocations and those maintaining their investments and looking to grow those and diversify. But broadly, digital infra, the energy transition, and climate change are three strategies which are proving popular in the space,” says Ubhi. 

As infrastructure has developed and sectors including energy transition and digital infrastructure have become more prominent, wider coverage by the mainstream media of government spending plans and high-profile M&A activity can also be a factor in driving LP interest in the space, say sources. Digital infrastructure has proved popular because of the effects of the Covid-19 pandemic, with hybrid working changing the face of the working world and requiring adjustments for people’s new daily lives. 

Tailoring exposure

“Investors are focusing on three significant trends which were accelerated by Covid-19: digital infrastructure, social infrastructure, and energy transition. We’re also seeing interest in core+ and value add strategies that are addressing these key areas,” says Redington research director, Jaspal Phull. 

Investors are looking to tailor their infra portfolios and increase their exposure to digital infra and energy transition. Some sector specialists in this space include DigitalBridge, SDC Capital Partners, GI Partners in the digital infra space, and Stone Capital Partners, Generate Capital, and Copehagan Infrastructure Partners in energy transition. 

Previously, insurance firms and pension funds were at the forefront of infrastructure allocations and those who allocated the most to the sector, due to the predictable nature of the asset class and for managing liability purposes, according to Goodwin partner, Shawn D’Aguiar. But McKinsey’s report also shows that new investors entering the space are increasingly seeking higher risk and return opportunities than those available to LPs in traditional infrastructure investments. 

2022 saw more LPs, specifically family offices and endowment plans, start investing in infrastructure according to Preqin research. Many of these will be looking for target returns in the mid to high teens, or above. 

In terms of how LPs are shifting their allocations, Minesh Mashru, global head of infrastructure investing, Cambridge Associates says that there’s still growing interest in PE allocations, but that LP portfolio buckets are diversifying, and often they are looking to infrastructure to do so. 

Interest in infrastructure as an asset class has also grown with the increasing prioritisation of ESG criteria by institutional investors. 

“There’s a natural alignment between ESG integration and infrastructure as an asset class. Investors want their GPs to better demonstrate ESG integration in their investment portfolios, and infrastructure is an asset class they can do that in, due to the renewable energy component and the energy transition,” outlines Ubhi. 

LP specialisation 

A third of fund managers are currently looking to invest in infrastructure assets in the green space, according to research from law firm Linklaters, and GPs in the space are working within Europe’s recent SFDR regulation to launch Article 8 & 9 funds to meet strict sustainable investment criteria. 

Indeed, there is increasing evidence that ESG investments can have a positive impact on portfolios, with a recent LP survey revealing that 74% of LPs believe strong ESG policies lead to better returns. 

Jayasingha says that WTW has been “paying much more attention to ESG, measuring carbon emissions over time and also assessing team-based inclusion and diversity aspects of GPs.” 

And increasing specialisation among LPs, by risk/return but also sector, now seems likely as the asset class grows. 

LPs are looking to focus increasingly on diversification and digging deeper into the asset class to find diversification, say sources. 

Infra portfolio constructions have become more sophisticated, with investors looking to balance their portfolios with large, diversified generalists and complement these with specialist players, according to Campbell Lutyens research. 

“I think investors will drill down further into infrastructure because of the potential for lower volatility over the long-term, as well as the long-term growth,” says Ubhi. 

The tailwinds remain largely positive for this asset class, with investors’ interest steadily growing and signs of this only increasing in the months ahead.

Read the rest of the Private Equity Wire Insight Report Pricing Power: How infrastructure funds are taking on inflation

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