Investors have increasingly been using alternative investment strategies to complement traditional asset allocations. Over the course of the last decade, we have witnessed considerable growth in exposure to real assets in general and to infrastructure in particular. As investors seek to improve the risk-adjusted returns of their portfolios, allocations to high-quality global core/core+ private infrastructure strategies can provide a number of important benefits. This primer provides an overview of private infrastructure as an asset class, describes the benefits of adding it to a diversified investment portfolio, and identifies some of the key implementation considerations for investors.
Over the past decade, we have observed that institutional and individual investors alike have increased their focus on allocations to private market investments as they seek ways to enhance returns and reduce the volatility of their portfolios. For example, many of Canada’s largest institutional investors have developed investment models with private infrastructure as a significant component of their policy allocations, as illustrated in Figure 1, which shows the growth in allocations across Canadian pension plans. More recently, smaller institutional and individual investors have followed, as access has improved through the development of investment vehicles specialized in the asset class.
Increasingly, investors are recognizing that the ability to capture the illiquidity and complexity premium present in private infrastructure—as well as its reduced correlation to traditional asset classes and potentially lower levels of overall volatility, which are demonstrated later in this paper—can add material value to a portfolio over the long term. In addition, the long-term nature of the asset class, with its stability of returns, consistency of income, and robust opportunity set, has driven many investors to take notice. These characteristics can make private infrastructure a suitable part of a diversified portfolio.
Figure 1: Canadian defined benefit pension plans, infrastructure allocation growth (2011-2021)
Source: Coalition Greenwich, Canadian Institutional Investors, 2021.
Private infrastructure: A large and growing investible opportunity set
Infrastructure consists of the tangible assets that support the activities of daily life and economic growth. Familiar historical examples include the ancient Roman aqueducts, which provided fresh water within the Roman Empire, or the Trans- Canada Railroad, which helped unite Canada as a nation.
Traditionally, governments have had the primary responsibility for funding and delivering infrastructure to their citizens. These investments were generally viewed as public assets, and were funded mainly through tax revenue. However, public sector balance sheets have come under increasing pressure and infrastructure spending has had to compete with other government priorities such as health care, social programs, and other initiatives. This has contributed to a trend that has diverted capital away from much-needed (but often longer-term) investments in building or updating critical infrastructure, and opened the door to the increased need for private capital.
As illustrated in Figure 2, the cumulative global need for annual infrastructure investment is forecast to reach USD$94 trillion by 2040, while spending is expected to fall short by USD$15 trillion over the coming two decades.1 This level of underinvestment has led to a need for more private sector capital to support these long-term investments. In fact, research indicates that in order for the world to reach net-zero carbon emissions by 2050, annual private investment in the low-carbon economy over the next ten years must be as much as eight times the amount committed in 2021.2
Figure 2: Projected annual global infrastructure spending gap
Source: Global Infrastructure Hub, Infrastructure Outlook, August 2022.
Historically, the private sector has invested in infrastructure via a number of different means. In North America, large publicly listed railroad companies invest in and upgrade tracks and rolling stock to ensure a timely delivery of goods. In Europe and South America, privately owned airport companies ensure that borders remain open for tourists, business travel, and cargo. In Canada, a large number of listed companies invest in the telecommunications and energy sectors. In other words, companies investing in infrastructure that is core for their business is not a new theme.
However, beyond these publicly listed companies (which fund investments from operating cash flows, or by issuing shares or raising debt), there is an established and accelerating trend whereby infrastructure projects are funded directly by private capital, especially from institutional investors such as large pension funds. Private capital has the advantage of aligning a long-term investment horizon with a long-term underlying asset, whereas listed companies are subject to the volatility of their own share price driving cost-of-capital decisions, and the potential negative impact to quarterly earnings per share (EPS) growth when they invest for the long term.
Because of the portfolio benefits to investors—outlined in the Portfolio Construction section later in this paper—there has also been an increase in the number of specialized managed solutions that provide investment access to private infrastructure assets. Funds and co-investment programs have gained considerable traction with individual and institutional investors who are seeking to replicate the investment programs of larger institutions but require the support of a partner to do so. Taken together with the aforementioned direct portfolios assembled by large institutional investors, total private capital invested in infrastructure is projected to grow from an estimated USD$864 billion in assets under management globally at the end of 2021, to USD$1.87 trillion by 2026, overtaking real estate to become the largest real asset class.3
Infrastructure 2.0: Investing in the future
One can think of well-invested infrastructure as a gift to future generations. Sometimes coined “Infrastructure 2.0,” these themes focus on ways in which investors can invest profitably with a responsible investing focus. These themes include energy transition, renewable power, the digital revolution, and clean water amongst others. Increasingly, environmental, social, and governance (ESG) factors have become key considerations in the search for responsible investing opportunities. To implement and manage ESG considerations, investors must apply a responsible investing model that embeds risk assessment and management over both the due diligence and ownership periods, and actively considers each investment’s role within the broader ecosystem. Correspondingly, aligned values, transparency, and governance are important elements of a responsible investing platform.