As low fixed-income yields force them to change their allocations, investors are looking to infrastructure as an alternative source of long-term returns.
- A decade of ultra-low interest rates and large-scale asset purchases by central banks has made infrastructure investments appealing to investors.
- Appetite for long-term investments has been increased by flattening yield curves, with U.S 10-year Treasuries currently yielding just over 1 percent.
- There is scope and momentum for the rapid growth of infrastructure, and institutional investors are keeping a close eye on the sector.
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In the Victorian railway boom of 19th-century Britain, many wealthy individuals bought shares in the country’s nascent railway companies with varying results: some profited hugely, while others suffered when a stock market bubble collapsed. Even so, thousands of miles of railway lines were constructed, contributing to the country’s economic prosperity.
Eyes are again turning to infrastructure investment, although mainly through private markets rather than public equities.
Consequently, it looks likely to become an increasingly important asset class for institutional investors seeking new sources of investment returns.
After a decade of ultra-low interest rates and large-scale asset purchases by central banks, infrastructure investments are looking increasingly appealing. Granted, there has been some compression in the returns offered by core assets such as water, electric and gas utilities, but they remain at a substantial premium to investment-grade corporate bond yields, averaging little more than 2 percent, and government bonds, at little more than zero.
Infrastructure as an alternative investment
Falling bond yields have encouraged investors to take more risk, buying assets such as junk bonds and technology start-ups. Logically, though, they would do better to invest in infrastructure.
There is certainly a need for their capital, at a time when government budgets are stretched to the limit by the costs of COVID-19 support, and infrastructure plays an important part in growth strategies like the European Union’s (EU) Green Deal.
Quantifying expectations of growth in this area, consultancy PwC forecasts that assets in infrastructure funds could double to approximately US$2trn by the end of 2025, given the need to refurbish roads, airports and hospitals, and to finance accelerating developments in areas such as 5G and renewable energy projects.
In fact, private investment has fallen over the past 10 years, and there is now a US$15trn investment gap out to 2040, according to the G20 Global Infrastructure Hub.This comes at a time when the IMF has called on rich nations to boost public spending on infrastructure to support economic recovery, encouraging further investment from the private sector.
But there are reasons why institutional investors such as pension funds have not allocated more. Typically, they have bought existing (‘brown’) assets and used these to generate cashflows. They have avoided developing new (‘green’) assets, regarding them as far too risky. So, why might this change?
What has caused this change in perception?
Firstly, there is the need for return. Like a drop of water in the desert, infrastructure offers the prospect of relatively high performance when yields from fixed-income securities are scarcely above zero.
Over the past 10 years, the EDHECinfra index of unlisted infrastructure securities returned 14.6 percent per annum. While returns vary significantly from one fund to another, and depend on the type of infrastructure invested in, this gives a sense of the potential level of outperformance.
Secondly, flattening yield curves have bolstered the attractiveness of long-term investments. U.S. 10-year government bonds yield just a shade over 1 percent today; not that much more than 2-year government bonds. That whets investor appetite for making longer-term investments.
Thirdly, as it becomes harder to generate alpha in public equities and bonds, so investors are turning to private markets, such as private equity, credit and infrastructure.
They are increasingly willing to take the business or development risk associated with building or improving an infrastructure asset. With core assets that offer the greatest resilience to economic downturns in high demand, there is a trend towards accepting these additional risks.
Watch: Infrastructure – The Big Explainer
Without doubt, there is increasing momentum for infrastructure to grow rapidly as an asset class Institutional investors certainly are exploring possibilities. More than half (56 percent) of those recently surveyed by Preqin expect to increase their allocations over five years, with just 7 percent expecting to lower allocations.1
Notably, there is a huge need for development of sustainable infrastructure, that is less carbon intensive, which will bring investment opportunities. Assets include renewable power, green transport, sustainable water and waste, and green buildings.
The EU alone, for instance, has highly ambitious plans for developing these assets as it seeks to meet its goals for a zero-carbon economy by 2050. It acknowledges that private finance will be needed if it is to avoid a funding shortfall.
Looking forward, it seems that once again infrastructure investment will become a more popular asset class as low yields force investors to consider other options.
Just as railways were a driver of economic growth and prosperity 200 years ago, so infrastructure assets from wind farms to 5G to green buildings are likely to be in the years to come.
1. Future of alternatives 2025: laying the foundations for infrastructure growth. Preqin. November 2020.