Infrastructure

Infrastructure as an alternative investment involves capital deployed into the essential physical assets and services that form the backbone of economies and societies. These investments are increasingly sought after for their stable cash flows, inflation protection, and diversification benefits.

Definition and Characteristics

Infrastructure broadly refers to the physical assets and services critical to the functioning of a region or country. These assets are characterized by providing essential services, often operating with monopolistic positions or high barriers to entry due to substantial capital investments and regulatory approvals.

Key characteristics of infrastructure investments include:

• Long Asset Life: Infrastructure assets typically have extended lifespans, often spanning decades or even centuries, contributing to their enhanced stability for investors.

• Stable and Predictable Cash Flows: These assets generally provide consistent and reliable income streams, often governed by long-term contracts (e.g., with government counterparties or regulated entities) or user fees. These cash flows frequently include explicit (e.g., inflation-linked payments) or implicit inflation protection.

• Inelastic Demand and Recession Resistance: The demand for many infrastructure services (e.g., water, power, transportation) is relatively insensitive to economic downturns, making these assets resilient during economic slowdowns and recessionary periods.

• Longer Investment Horizon: Infrastructure investments typically align with a longer investment horizon compared to other asset classes.

Types of Infrastructure Assets

Modern infrastructure encompasses a wide array of assets, categorized into four core classes:

• Transportation: Traditional infrastructure assets facilitating the movement of people and goods, including toll roads, bridges, tunnels, airports, ports, rail, mass transit, and parking facilities.

• Digital Infrastructure: Assets supporting modern connectivity and data, such as communications towers, fiber optic cable networks, and data centers.

• Energy: Assets related to power generation and distribution, including renewable power (hydro, wind, solar, distributed generation, storage), conventional generation, and electric/gas assets.

• Social Infrastructure: Facilities and services that serve a social function and provide necessary amenities to a population, such as healthcare facilities, educational institutions, assisted living facilities, student housing, childcare centers, and affordable housing. Water and wastewater management systems are also included.

Investment Thesis and How to Invest

The investment thesis for infrastructure centers on providing the capital necessary to repair, maintain, and build new infrastructure, addressing a significant global investment gap (e.g., an estimated $15 trillion gap by 2040 globally, and $2.5 trillion in the U.S. for 2020-2029).

Infrastructure investments are often categorized by their risk/return profile and development phase:

• Core Assets: These are typically operational, mature assets with limited volumetric risk and high margins, generating stable, predictable cash flows primarily from yield. They are generally considered the least risky.

• Core Plus Assets: Similar to core but with more variable cash flows, often having growth- or GDP-linked components, and targeting a higher rate of return than core.

• Value-Add Assets: These assets have greater market competition and potential for growth or repositioning, with returns primarily driven by capital appreciation. They carry higher risk and typically have shorter hold periods (5-10 years).

• Opportunistic Assets: These offer the highest degree of risk and return potential, often involving assets in development (greenfield projects), emerging markets, commodity-dependent assets, or distressed situations. Greenfield projects, being brand-new developments, offer higher return potential but also come with more construction and operational risks. Brownfield assets, which are already operating and generating cash, tend to have more predictable cash flows.

Investors can gain exposure through publicly listed infrastructure companies or funds, or through private investments in unlisted infrastructure funds or direct assets. Private infrastructure funds often aim for steady, long-term cash flows derived from user fees, contracts, or utility rates. Fund structures can vary from finite-life drawdown vehicles to evergreen, fully funded structures that offer periodic redemption opportunities. Private infrastructure investments can also offer meaningful tax advantages through depreciation shields and long-term capital gains treatment, with some projects qualifying for government incentives like tax credits.

Risks in Infrastructure Investment

While known for stability, infrastructure investments are subject to various risks:

• Illiquidity: Infrastructure is a highly illiquid asset class, typically held for long periods (over ten years), which means capital is locked up for an extended duration.

• Regulatory Risk: Changes in regulatory frameworks, including retroactive taxes, tariff rate reductions, or new regulatory regimes, can significantly impact returns.

• Political Risk: Geopolitical tensions or national government interventions (e.g., dismantling regulatory bodies, renationalization, not renewing concessions) can have a substantial impact on the sector.

• Environmental and Climate Impacts: Infrastructure assets are vulnerable to long-term sustainability risks such as climate impacts, changing environmental regulations, and biodiversity impacts.

• Operational and Technical Risk: The complexity of infrastructure projects can lead to operating and technical challenges, requiring qualified personnel, sound business plans, and appropriate insurance.

• Blind Pool Risk: Investors in private market infrastructure funds may commit capital to "blind pools" without prior knowledge of the specific investments the fund will make.

• Social and Technology Risks: Social movements and disruptive technological changes can also pose significant risks and opportunities for infrastructure investments.

Historical Performance and Diversification Benefits

Infrastructure investments can be a powerful addition to portfolios due to their potential for diversification. They generally exhibit low to moderate correlation with traditional asset classes like stocks and bonds. This low correlation helps reduce overall portfolio volatility and can materially improve a portfolio's risk-adjusted return.

nfrastructure returns are relatively resilient to economic turbulence, remaining stable even in recessionary environments due to their essential nature and often contracted or regulated revenue streams. During the Global Financial Crisis (GFC), private infrastructure experienced significantly smaller drawdowns (23.2%) compared to the S&P 500 (43.9%). Similarly, after the 2022 Fed rate hikes, private infrastructure funds showed minimal movement while public equities suffered a substantial drawdown.

Infrastructure assets are also effective hedges against inflation. Many assets have explicit inflation-linked payments in their contracts or implicit inflation protection through periodic rate adjustments. Since 2007, private infrastructure funds have consistently outperformed public equity, bond, and private real estate indices during quarters with above-average inflation. For example, in high-inflation quarters between December 2007 and March 2023, private infrastructure funds returned 5% annually, compared to 0.9% for the S&P 500. This demonstrates their unique ability to not only mitigate but potentially benefit from rising prices and interest rates.

Overall, private infrastructure has provided a similar total return as public equities (S&P 500) over the last 15 years, but with significantly lower volatility. This favorable risk/reward profile, combined with income generation potential and resilience to interest rate increases, makes infrastructure an attractive strategic allocation for long-horizon investors.

Industry Associations and Data Providers

Key players and resources in the infrastructure investment space include firms like KKR, HarbourVest, Arta Finance, and CAIS Group, which are active in private infrastructure investments. Industry associations like the Wireless Infrastructure Association (WIA) represent companies within the wireless infrastructure ecosystem.