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Why inflation fears are lifting infra funds

Infrastructure as an asset class proved its resilience during the pandemic and continues to grow in terms of AUM. Now LP investors want to see if it has the inflation protection it has always been associated with too…

Infrastructure as an asset class proved its resilience during the pandemic and continues to grow in terms of AUM. Now LP investors want to see if it has the inflation protection it has always been associated with too…

Infrastructure investment looks set to continue its global ascent in 2022 as the fastest-growing alternative asset
class by fundraising and AUM. Assets under management (AUM) will reach USD1.87 trillion by 2026, according to Preqin, overtaking real estate to become the largest real asset class.

Nearly half (47 per cent) of investors told Preqin that they planned to increase their long-term allocation
to infrastructure, with just 7 per cent intending to reduce it. Inflation is the backdrop, as investors seek to improve real returns across many regions, and the asset class has proven to be resilient – average net IRR last year recovered to around 14 per cent following the shock of the pandemic.


In April, one of the world’s largest infrastructure asset managers, IFM Investors, reported that infrastructure investments are largely “positively correlated to inflation,” which could provide a cushion to any more macroeconomic uncertainties that could occur in 2022. Days later, Blackstone CEO Steve Schwarzman said in an earnings call that “owning hard assets has historically provided a strong hedge for inflation which favors our infrastructure business”.

Infrastructure assets are well- positioned to perform in higher inflation environments and manage increases in interest rates.

Of all the market factors, inflation is leading the discussion among LPs and naturally is influencing fundraising strategies and fund caps, says Recep Kendircioglu, co-portfolio manager and head of infrastructure investments at Manulife Investment Management, which in November 2021 made the final closing on its USD4.65 billion Manulife Infrastructure Fund II.

“The discussion among LPs last year was more about finding an alternative to fixed income. Today, that discussion is much more about inflation,” says Kendircioglu.

“The prolonged uncertainty of the pandemic made more investors realise that infrastructure was becoming more attractive with its inflation protection even months before the current situation in Ukraine,” says Vincent Levita, founder and CEO of InfraVia Capital Partners, which closed a 5th infrastructure fund at EUR5 billion in March and is now developing what Levita calls a “privateequity style platform” for core-plus infrastructure opportunities.

Devilish details

Not all infrastructure investments will be inflation- proof, though.

“While infrastructure does offer a level of inflation protection, the devil is in the detail in what you invest in and if it is truly core,” Kendircioglu notes. “GPs entering from the private equity space must consider that there are limits to which customers are willing to pay even for essential services and what is politically acceptable.”

The quasi-monopolistic nature of most infrastructure assets means that demand often tends to be inelastic so inflation can often be passed on to customers through increased tariffs. Indeed, for regulated infrastructure sectors – such as water, power grids or toll roads – regulation generally features an explicit inflation-link, allowing tariffs to increase in line with inflation.

“If you’re in an asset class that has no pricing power, or no inflation escalation in your contracts, then it will be harder to pass on inflation. The flip side is if you can manage input costs and or pass a portion of those on in tariffs, you’ll do better in an inflationary environment,” says Neil Brown, partner and head of the investor development group at Actis, which closed its global USD6 billion Actis Energy 5 Fund last October, exceeding its USD4billion target.

Infrastructure assets are also typically long- duration and require large upfront capital expenditures with comparatively less required in terms of annual maintenance or operating expenses, limiting cost pressures. Renewables, such as solar power plants, are a good example.

“Regulatory risk is on top of everyone’s mind, which is why we love power, since governments rarely make radical changes over it,” says Brown. “There have been some exceptions over the COVID pandemic, and in places such as in Spain and Italy, but for the most part, power is a less risky sector since no one wants the lights to go out.”

Over the past two years, private equity houses and infrastructure funds have been answering the call from their investors with ever larger funds.

In April, I Squared Capital closed the ISQ Global Infrastructure Fund III at USD15 billion to invest in renewables and the energy transition, supply chains and logistics, digital infrastructure and transportation.
Weeks earlier private equity firm KKR raised USD17 billion – almost USD10 billion larger than its previous infrastructure fund. Stonepeak’s USD14 billion Infrastructure Fund IV was almost double its 2018 USD7.2 billion predecessor fund. Brookfield and Global Infrastructure Partners
are both targeting USD25 billion for new infrastructure funds, according to reports in February.

Smaller debut infrastructure funds from private equity GPs are also growing in number.

Brown at Actis sees GPs, predominately multi-asset managers, carving out a future for themselves including in the core-plus space.

GI Partners was among the first group of private equity managers to move into the infra fund market with a strategy targeting assets in data centres and tech-enabled infrastructure. Others include EQT, Carlyle and Intermediate Capital Group (ICG).

Gordon Bajnai, head of global infrastructure at placement agent Campbell Lutyens, is expecting a “boom year” for infrastructure fundraising in 2022 with more private equity players joining the “bonanza”. He clarifies, though, that private equity players dabbling in the infrastructure market is “nothing new” and those that have entered the segment have set strategies on the 15 per cent and above returns model, rather than the typically lower ‘core infrastructure’ risk segment.

Private equity players with a successful track record in telcoms, technology and energy will be looking to diverge into the “mega” fundraising trends of digitisation and energy transition, says Bajnai. But not all of them will find success.

“It’s not easy to come from private equity into infrastructure. It’s not a no-brainer. Some people have tried and failed. It’s a different world and network. To be taken seriously you need to have a senior partner dedicated to the fund who knows the infra lingo and industry network to source deals. That senior talent may have to come from your existing TMT or energy team or be hired externally. The thing is, private equity guys may be dealing with the same LP,
but it will be from the infra department that will be expecting an infra mindset and a compelling story to tell.”

With recent core infrastructure funds raised by Macquarie and EQT, segmentation is clearly becoming a larger part of infrastructure fundraising to meet LP demand for opportunities in the energy transition and digitisation.

Private equity funds can expect average returns of between 15 per cent and 20 per cent for digital infrastructure investments when they are being built but post-construction, the contracted risk typically reduces returns to around 10 per cent or below, allowing them to be sold on to a lower risk buyside group such as a pension fund.


Such a strategy also lends itself well to open- ended infrastructure funds, says Alastair Yates, Managing Director, Macquarie Asset Management.

“I think there’s been a greater realisation that putting core infrastructure investments that deliver yield, which act more like a replacement to fixed income, actually make more sense in an open- ended fund where you don’t have that need for constant churn. It also means smaller clients can get access to those investments, that maybe for the past few years had gone only to larger investors,” he says.

Open-ended infrastructure does not have to be strictly in the core space, though. French private equity firm Ardian was reported in April to have launched its first open-ended infrastructure fund – an SFDR Article 9 vehicle targeting the energy transition, with a target of EUR1 billion. Blackstone’s open-ended infrastructure strategy has raised USD27 billion, it said in April.

For new entrants, finding the appropriate position on infrastructure risk-return spectrum will be key in the economy that awaits. “You can still be a meaningful player in infrastructure at reasonable fund sizes, where there are lots of respectable firms, with many funds closing on USD5 billion and rising,” says Brown.

“It’s an attractive proposition when you couple growth with the infrastructure sector’s market structure. From a supply perspective, it’s not dominated by 10 large buyout firms. There’s an open canvas that leaves plenty of scope for the big pure-play infrastructure players and the mid- market funds.”

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

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