Why exposure to infrastructure still makes sense
Investment in private infrastructure – for example renewable power plants, hospitals or airports – is still a relatively new opportunity for retail investors: the inclusion of infrastructure assets in investment trusts over the past 15 years or so is an indication of the sector’s appeal.
But 2023 was a year unlike any previous one in the short history of the asset class, fuelled by soaring inflation, painful interest rate hikes and fears of recession. Investors backed off, worried about the accuracy of asset valuations and the impact of rate rises on returns. However, despite continuing macro-economic uncertainty, we believe that there are several strong reasons to feel optimistic about the outlook for private infrastructure.
Infrastructure - an essential part of society
First, although inflation and interest rate increases took their toll on the fundamentals of most private asset classes last year, the services provided by core infrastructure assets – notably transport and energy networks – play an essential role in today’s world, making them effectively ‘cycle agnostic’.
As a consequence, their investment returns have remained relatively resilient to economic stresses such as we have experienced recently (and indeed they behaved similarly in the face of previous crises such as the 2008 global financial crash and the Covid pandemic). Those assets with long-term financing arrangements in place - often fixed for well over 10 years – are able to generate particularly stable cash flows.
A provision for inflation
A further strength is the fact that typically provision for inflation is built into their financial structure, in the shape of inflation-adjusted cash flows or inflation-linked returns.
One such example is the rail leasing industry. Rent in this context is usually broken down into capital and maintenance rent; although the capital rent element rarely incorporates explicit inflation linkage, maintenance rent contracts generally do, and these have resulted in significant price increases over the past two years.
Another important consideration is the capacity of the core services delivered by these assets to pass costs on to consumers. Higher prices can help to offset the erosive impact of inflation and rate rises on cash flows, although in some cases there is a lag before price rises can be implemented.
Given the strong fundamentals underpinning the asset class and the robust nature of infrastructure cash flows, we expect valuations to remain relatively stable based on current inflation and interest rate expectations.
Are infrastructure projects increasing?
Looking ahead, there are clear signs that investment opportunities are on the rise.
For a start, the current pipeline of capital projects seeking funding more than accounts for the ‘dry powder’- the capital committed to private investment currently awaiting allocation. That trend towards increasing competition for funds will only be magnified by the transition to greener energy and the need to modernise, replace and decarbonise existing infrastructure assets.
Taking the UK as an example, in October 2021 the Government set an ambition for all electricity generation to be decarbonised by 2035. But a recent report from the House of Commons suggested there is a lot that needs to be done to meet that target, with gas still accounting for 40% of our electricity supply1.
Indeed, the pressure to transition to a low-carbon operation globally may result in an upturn in financial and corporate owners looking to sell because they cannot meet the capital requirements – providing further potential openings for well-capitalised investors.
Given the dynamics of the energy transition plus the fact that investment capital has been so hard to come by over the past difficult year, we anticipate that there will also be demand for additional ‘follow on’ investment.
The bottom line is that for the first time in this maturing asset class, capital expenditure (the money companies use to purchase, upgrade or extend the life of an asset) is expected to outpace depreciation for at least the next decade. And that amounts to terrific opportunities for investors in a position to take advantage of them.
Overall, the outlook is a positive one for 2024 and beyond. We expect core private infrastructure to generate strong risk-adjusted returns with low correlation to conventional investments, consistent cash yields and an ongoing, in-built inflation provision.
How can retail investors make the most of infrastructure opportunities?
For retail investors looking for exposure to this asset class, JPMorgan Global Core Real Assets Limited (JARA) is an investment trust investing in a range of global real assets. The trust benefits from not only access to one of the world’s largest alternatives platforms, but over 30 years’ experience of the Alternatives Solutions Group, and 300+ investment professionals specialising in alternative investments.