Investment Perspectives

Global Next-Generation Infrastructure: A Core Plus Strategy for the Mid-Market

February 14, 2024 10 Minute Read Time

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Introduction

Infrastructure’s performance on a relative and absolute basis and from a risk-return perspective is impressive over one, three, five and 10 years. Regardless of the geopolitical or economic backdrop, people still need water, still need electricity, still need to travel and still need digital connectivity. The essential nature of these services is behind infrastructure’s unique return stream, which typically includes a large cash flow component, inflation linkage plus the potential for growth. Hundreds of billions of dollars each year are being invested in the asset class to take advantage of these returns. Maximization of infrastructure’s attractive risk-return profile is key to a successful strategy, particularly in today’s uncertain macro environment. Global Next-generation Infrastructure strategies, focused on downside protection and secular growth, address this need.

Infrastructure–a unique asset class

Infrastructure is a unique and attractive asset class for investors because of the following:

High and stable cash flow: the provision of essential services based on multi-year contracts with governments or other creditworthy off-takers enables infrastructure assets to generate long-term and predictable cash flow.

Inflation linkage: long-term contracts can include escalators or a degree of indexation that protects against inflation.

Attractive risk-adjusted returns: inflation-protected, high-yielding returns, together with the essential nature of the services provided, make infrastructure more resilient to GDP shocks.

Portfolio diversifier: resilience in the face of economic uncertainty and stable cash flows enables infrastructure to withstand market volatility better than other asset classes.

High barriers to entry: infrastructure assets are capital intensive and not easy to replicate.

A long-term track record of generating consistent returns across market cycles sets infrastructure apart from other asset classes.

Infrastructure – a proven performer

The graph below compares the returns generated by listed and unlisted infrastructure with those of equities and bonds from Q2 2016-Q2 2023. As can be seen, both listed and unlisted infrastructure delivered equity-like returns while exhibiting bond-like volatility. Listed infrastructure, represented by the teal line, is highly correlated with equities, which is not surprising given it is an aggregate of vehicles traded on public markets and more exposed to market movements. The drawdowns seen in unlisted infrastructure (represented by the black and gold lines) are less steep, particularly during the period of volatility that followed the outbreak of COVID-19 in early 2020.

Stable unlisted infrastructure performance & strong year for equities

Chart showing Stable unlisted infrastructure performance & strong year for equities

1 Unlisted infrastructure as of Q3 2023; Listed infrastructure, Bonds & Equities as of Q4 2023. Source: Refinitiv, Factset. Unlisted infrastructure: Cambridge Associates Global Infrastructure Index in USD, net of fees as of Q3 2023. Listed infrastructure: FTSE Global Core Infrastructure 50/50 index in USD as of Q4 2023. Bonds: Bloomberg Global Aggregate Fixed Income index in USD as of Q4 2023. Equities: MSCI World index in USD as of Q4 2023.

For illustrative purposes only. Current market conditions differ from prior market conditions; including during prior periods of stress and dislocation. There can be no assurance any prior trends will continue.
Whether unlisted or listed, infrastructure has a strong track record. Maximizing the favorable risk-return characteristics generated by the asset class represents an opportunity for investors.

An evolving asset class

Infrastructure is an asset class that is evolving in terms of preferred geographies, sectors, available fund structures and implementation considerations (funds/co-investments/secondaries/directs). Given a lack of industry consensus over benchmarks to assess performance and a plethora of funds available with a diverse range of strategies requires careful navigation of the sector.

Focusing on downside protection and secular growth

We believe that returns can be maximized and risks minimized when investing in infrastructure by:

  • Going global
  • Investing in the mid-market segment
  • Prioritizing Next-generation Infrastructure over legacy sectors
  • Optimizing fund structure

By doing the above, we can expand the opportunity set which helps diversify risk while opening up avenues of growth.

Going global: Infrastructure assets generate attractive risk-adjusted returns, but still come with a degree of risk. Investing in global developed markets helps to reduce the risks in the following ways:

  • Portfolio risk reduction: Listed and unlisted infrastructure returns are strongly, but not perfectly correlated across major regions. Going global helps to diversify portfolios.
  • Idiosyncratic risk mitigation: A multi-regional strategy can reduce the impact of economic and geopolitical crises at the macro level as well as any negative effects of regulatory reviews at the micro level. A portfolio’s downside protection is enhanced.
  • Access to more sectoral opportunities: Certain regions are more exposed to specific sectors than others. A multi-regional approach enables portfolios to diversify at a sectoral level. For example, in the U.S. the energy and power sectors drive more opportunities for private investors. In Europe and Asia, as the graphic below highlights, private capital is finding more opportunities within transport and renewables.

Sector share of private infrastructure M&A deals (last 5 years, 2019-2023)

Chart showing Sector share of private infrastructure M&A deals (last 5 years, 2019-2023)

Source: Infralogic, February 2024.
CBRE Investment Management analyzed the performance of regional and unconstrained global unlisted infrastructure portfolios. We reviewed over 18 years’ worth of data from two unlisted infrastructure index providers, EDHECinfra and Cambridge Associates. As the table below demonstrates, a globally diversified infrastructure portfolio generates a superior risk-return profile compared to investing in a single region:

Regional and global infrastructure portfolio metrics

Chart showing Sector share of private infrastructure M&A deals (last 5 years, 2019-2023)

Source: Investment Management opinion based on internal research and view of investible universe of each region.
Source: Cambridge Associates index North American funds, in USD (de-smoothed by CBRE Investment Management), unlisted Europe: EDHEC infra100 Europe, unlisted Asia: EDHEC infra Asia Pacific. EDHEC indices in local currency, adjusted for estimated fees. Period: Q2 2005 to Q3 2022. Risk free rate: Factset. Calmar ratio: average annual rate of return, divided by the maximum drawdown.
Mid-market segment: An asset class known for its consistently high levels of cash flows and resistance to downturns is typically highly prized. In the crowded market for larger assets with enterprise values of more than US$2 billion, assets can become too expensive to acquire; the economics may no longer stack up and opportunities may be limited due to increased competition for assets. The mid-market segment (which we define as having enterprise values of between US$500 and US$2 billion), is not experiencing this issue.

With competition fierce for larger assets and infrastructure fund sizes growing, the mid-market segment can be overlooked. However, there are many good reasons to consider mid-market opportunities. Assets can be secured through relationships rather than through a competitive process. There are more overall opportunities transacted in the mid-market. Pricing tends to be more attractive. Owing to the smaller ticket sizes, there’s more scope for value creation, such as delivering projects on time and on budget. Better pricing plus more growth opportunities can lead to better performance. As the graphic below shows, over the five-year period from 2018-2023, the mid-market infrastructure segment outperformed general and core infrastructure strategies.

Why mid-market?

Source: Infralogic as of October 19, 2023. Transaction data for last five years (10/19/2018 – 10/19/2023). Includes greenfield, M&A, take-private and privatization deals; excludes additional financings, refinancings, nationalizations and public offerings. Returns based on EDHECInfra as of Q3’2023. Gross of fees, equally weighted and in local currency. Return period is last five years.

For illustrative purposes only. Current market conditions differ from prior market conditions; including during prior periods of stress and dislocation. There can be no assurance any prior trends will continue.
Mid-market’s higher returns have not come at the expense of higher risk. The graphs below show superior annualized returns over three-, five- and ten-year timeframes. They also highlight maximum drawdowns that are either smaller or equal to larger size assets.

Suggested weighting based on mean-variance analysis of historical returns

Chart showing Electric Vehicle sales by region, 2022-2030 (millions of vehicles)

Sources: EDHECInfra100 Midmarket, EDHECInfra100 Global. Based in local currency. As of 9/30/2023. Assumptions are generalised to provide a consistent market outlook and asset specific strategies have not been taken into account. Forecasts are inherently uncertain and subject to change. Actual results may vary. There can be no assurance any targets or allocations will ultimately be achieved.
Next-generation Infrastructure: While opting for mid-market assets can enhance returns, choosing the right sectors is still key. Next-generation Infrastructure covers sectors that benefit from long-term structural drivers, such as those that have a significant role to play in solving societal challenges, such as achieving sustainability goals, addressing the digital divide and improving the affordability and efficiency of energy and other essential services. Tackling these challenges requires substantial capital. Governments will struggle to fund the levels of investment needed on their own. Private capital has a significant role to play. Below are examples of next-generation infrastructure sectors and the opportunities they present:

Source

  • Clean transport: A clean transport network relies on electrification. Electrification requires major investment in power generation and transmission, smart grids and electric vehicle (EV) chargers. A closer look at the availability of EV chargers highlights the scale of the challenge ahead:

Electric vehicle sales, 2022-2030 (millions of vehicles)

Chart showing Suggested weighting based on mean-variance analysis of historical returns

Source: International Energy Agency (IEA), Global EV Outlook 2023, April 2023. The Stated Policies Scenario (STEPS) provides an outlook based on the latest policy settings, including energy, climate and related industrial policies. The Announced Pledges Scenario (APS) assumes all national energy and climate targets made by governments are met in full and on time.
Although the number of global public electric charging infrastructure connectors has grown significantly in recent years, more growth is required. In the U.S., for example, the Biden administration has set a goal of installing 500,000 public chargers nationwide by 2030. According to McKinsey, this may not be enough. For the U.S. to meet its goal of EVs accounting for half of all vehicles sold by 2030, 1.2 million public chargers, as well as 28 million private chargers, will be needed. The required increase in charging capacity will also cause a significant increase in electric power demand—approximately 5% of current U.S. demand. A lot more investment is needed, creating opportunities for private capital.

Case study: The world’s first liquid hydrogen ferry

Norled is the largest express boat operator and the second largest ferry operator in Norway with 41 ferries and 39 express boat vessels, which exclusively operates c. 50 routes across Norway through gross contracts with availability-based payments from governmental counterparties. Norled provides an essential public transport service for commuters and freight in an area where alternative modes are either not available or not competitive due to coastal geography.

Contracts are underpinned by long-term concessions and are availability-based so there is no volume risk. They are also index-linked, providing inflation protection. As a result, the business generates predictable cash flows and offers downside protection.

Norled is a pioneer in emissions-free maritime transportation. It was the first to deploy electric ferries on water and in Q3 2023, Norled fully commissioned the world’s first liquid hydrogen ferry. More than 40% of the 80+ vessel fleet is run on low-emissions technologies. Norled has also launched several strategic initiatives focusing on energy consumption, crew optimization and procurement.

Case study: A pan-Scandinavian bus transportation platform

Connect Bus is a Nordic public transport operator active in Norway and Sweden with a total of +2,700 vehicles stretching across +100 contracts. The majority of contracts (>90% of revenue) are underpinned by gross contracts with availability-based payments from governmental counterparties for providing public transportation services.

With contracts underpinned by long-term concessions, there is no volume risk. The contracts are availability-based and index-linked delivering predictable cash flows and downside protection. Due to the critical need for public transportation, market growth for the company is inherently non-cyclical.

Formed by combining individual Scandinavian bus operators to create a pan-Scandinavian bus transportation platform, the business benefits from high barriers to entry. Connect Bus’ strong balance positions the company well to win future tender opportunities where value is ascribed to quality and other non-price metrics. The business was awarded a new tender in Q2 2023 totalling 140 buses (~40% biofuel, remaining BEVs). The fleet currently includes approximately 300 electric buses.

Digital infrastructure: According to The World Economic Forum, approximately 60% of global GDP relies on digitalization and this is expected to increase as new technologies, such as AI, become more entrenched in everyday life. As reliance on digitalization grows, so does the need for updated infrastructure such as data centers, mobile towers, smart meters and fiber optic networks.

Case study: Improving the learning experience for 300,000 students

WANRack, a provider of broadband connectivity services to K-12 school districts across the U.S., specializes in developing custom-built private fiber networks under long-term contracts backed by the U.S. government.

With over 1,000 miles of newly constructed fiber networks, WANRack currently services more than 848 schools. By addressing the “homework gap” – when students cannot complete assignments due to lack of reliable internet at home – these networks have dramatically enhanced the education experience for more than 500,000 students. Fiber presents an excellent investment opportunity as a long-lived, core infrastructure asset that generates increasing returns over time and benefits from capital appreciation. It also delivers valuable social benefits, bridging the digital divide for those underserved currently, and enhancing economic activity more broadly as more businesses, particularly small businesses, become connected to high-speed internet.

Renewable energy: As well as aiding net zero ambitions, renewables also make sense from a geopolitical and an economic perspective—geopolitical in terms of energy security and economic in terms of falling costs. As the graph below shows, over the last decade, the cost of developing renewable energy, such as solar photovoltaics (PV) and onshore/offshore wind, has fallen so that in many countries, the costs associated with renewables are just as, if not more, competitive than natural gas.

Utility scale solar PV costs versus natural gas (fuel and CO2) cost in Europe (2021 USD/KWh)

Chart showing Utility scale solar PV costs versus natural gas (fuel and CO2) cost in Europe (2021 USD/KWh)

Source: IRENA. Renewable power generation costs in 2021. Note: 2022 values are possible outcomes and not a forecast.

Case study: Pioneering ‘behind-the meter’ power generation

Organizations looking to lower their carbon footprints and reduce energy costs are increasingly opting to install their own renewable energy generation capabilities. Green Peak Energy is one of Australia’s leading providers of behind the-meter and rooftop solar solutions for commercial and industrial customers. Green Peak provides all-in-one Power Purchase Agreement solutions that lower energy costs for businesses of all sizes. With businesses striving to improve their sustainability credentials and meet net zero targets, Green Peak is expected to benefit as the clean energy transition accelerates.

Source

Optimal structure: Investors have a wide choice when it comes to choosing how to gain exposure to infrastructure. Picking the right structure, for example, open-end or closed-end funds, can impact overall performance. We believe that for global infrastructure strategies focused on the mid-market segment, open-end funds have clear benefits.

Open-end funds are not tied to a specified investment period or subject to continuation vehicle votes (as closed-end vehicles increasingly are). Open-end funds are particularly well-suited to provide the significant levels of capital required over time in the attractive mid-market segment. Open-end funds also assure alignment of investment horizons. Open-end funds are better suited to the long, often generational, timeframes associated with next-generation infrastructure themes compared to closed-end funds which can have limited shelf-lives and might sell investments too soon.

From an investor point of view, open-end funds provide enhanced liquidity throughout the economic cycle. For example, open-end funds enable investors to redeem their holdings as and when their objectives change. Or for those needing to supplement yield through capital growth, a partial redemption strategy can be deployed. For investors who do not need liquidity, open-end funds enable assets to be held indefinitely or for yield to be re-invested, investors benefitting from the compounding of returns.

Open-end funds also tend to have a lower fee load. Along with lower management fees, there are often no fees charged on committed capital. Performance fees tend to be lower too, and as the size of the fund and portfolio increases, there can be scope for fees to fall in the future. Meanwhile, the lack of a need for continuation vehicles removes another layer of fees.

These benefits, and others, position open-end funds as an attractive way to access the infrastructure asset class. 

Summary

Infrastructure is an asset class that has delivered strong performance. Core plus and value creation strategies focused on downside protection and secular growth can go further to help maximize infrastructure’s attractive risk-return profile. Maximizing performance can be achieved by being nimble and flexible, investing globally in mid-market assets operating in next-generation infrastructure sector and by using an optimal fund structure. We believe that in today’s challenging economic and geopolitical environment, next-generation infrastructure core plus strategies through an open-end fund is a timely investment opportunity.