Concentrating on the core
For the better part of a decade, and in particular over the last five years, institutional investors have increasingly embraced the potential of equity investment in core private infrastructure assets: diversification, inflation protection and yield. Now, late in the economic cycle, they are asking how opportunities can best be seized and risks most effectively managed.
From a financing perspective, infrastructure debt is an increasingly mature market in which institutions compete against banks and sit together in new financing structures. We see no letup in the terms on offer for financing core assets—despite historically low base rates and cyclical, regulatory and political uncertainties.
Too much money chasing too few deals?
As a core infrastructure equity investor, we are hearing a refrain that has become more frequent in late cycle: “Too much money is chasing too few deals.” Yet this narrative doesn’t capture the full picture. Although significant capital has been raised, it is from a relatively low base, and private capital remains a small percentage of the market’s overall financing. And while equity returns have fallen on an absolute basis over time, in our view they remain quite attractive relative to traditional asset classes, particularly on a risk-adjusted basis.
We continue to find promising transactions for middle market regulated and contracted assets in OECD markets, mostly in the U.S. and Western Europe. Mid market transactions represent more than 90% of all infrastructure transactions, and they are generally insulated from the typically intense competition for large, core “trophy” assets—where the “too much money” narrative often arises (EXHIBIT 1).
Mid market transactions are generally insulated from the intense competition for large, core trophy assets
EXHIBIT 1: INFRASTRUCTURE TRANSACTIONS, 2010–19
Source: J.P. Morgan Asset Management; data as of November 30, 2019.
Taking a “strategic platform investment” approach, we make bolt-on acquisitions and also deploy equity capital in our portfolio companies. This approach seeks more efficiently deployed capital and less competitive processes, while allowing us to enhance our existing businesses and management teams. Examples include adding solar assets to a broadly diversified solar portfolio and expanding a regulated utility into a new jurisdiction, organically or by acquisition.
As a debt investor, we focus on those sectors offering real barriers to entry and visibility of cash flows, noting that the “energy transition” away from fossil fuels is presenting challenges as well as new investment opportunities.
Not straying from the core
We continue to view core infrastructure equity risk-adjusted returns as attractive on a relative basis. But as the “too much money chasing too few deals” narrative suggests, we are seeing some investors increase their risk tolerance in order to maintain expected returns. Whether that takes the form of investing in new geographies or sectors, the additional return does not come without additional risk.
Particularly in a late-cycle environment, we concentrate on assets that fit the established definition of “core,” chiefly the ability to provide clear visibility into long-term yield. True core infrastructure assets can offer low volatility, low correlation to equity and fixed income, and reliable cash yield streams. In late cycle, especially, we believe that diversification and downside protection will serve investors well.
ESG and renewables
A focus on environmental, social and governance (ESG) consider¬ations continues to be fundamental as we look to optimize risk-adjusted returns. An ESG focus aligns closely with the objectives of infrastructure investments, in both equity and debt.
For example, renewable energy’s environmental benefits are lifting both supply and demand in the sector, resulting in the availability of long-term contracts that are aligned with the investment objectives of the infrastructure asset class. Indeed, renewables have become a mainstream infrastructure sector in the past decade. We see evidence of that trend in both supply and demand dynamics.
Boosting demand: new government targets for increasing renewable production’s share within the overall energy mix; changes in corporate strategy and consumer preferences that are broadly driving sustainable consumption and investment.
- Increasing supply: Greater economies of scale are delivering lower costs for wind and solar power generation, with wind/ solar now the most cost-effective option for new generation in many jurisdictions. Energy-related infrastructure financing now makes up the bulk of new financing; renewable transactions’ value has caught up to conventional power and is far ahead in number (EXHIBIT 2).
Energy-related infrastructure financing now makes up the bulk of new financing
EXHIBIT 2: GLOBAL VALUE BY SECTOR (USD BILLION)
SSource: IJGlobal 2015, 2016, 2017 and 2018 Infrastructure and Project Finance League Table Reports.
Investing in infrastructure debt, like infrastructure equity investing, puts ESG at the forefront. The alignment of renewable energy demand and supply drivers has spurred a sharp uptick in the need for financing. This will likely lead to greater infrastructure debt allocations to the renewables sector.
OVERVIEWS AND OUTLOOKS BY ASSET CLASS