Infrastructure: The Rise of a $1 Trillion Asset Class

The rise of infrastructure as an asset class has been a significant development in the investment landscape over the past few decades. Traditionally dominated by public sector funding, infrastructure investments have increasingly attracted private capital, reshaping the way essential assets are financed and managed. A combination of factors is behind the shift, including the public sector's need for improved infrastructure and the private sector's search for stable returns.

The very definition of infrastructure is also evolving. What was once thought of as an investment in transportation or utilities has expanded to include services critical to the functioning of society. For example, the asset class now includes investments in social welfare such as healthcare and education, and investments in digital facilities through fiber optics, cloud computing, and data storage.

Goldman Sachs research reports that private infrastructure AUM surpassed $1 trillion and is expected to increase to more than $3 trillion by 2035.¹ BlackRock's acquisition of GIP and General Atlantic's Actis deal, being two recent examples, also highlight the push on infrastructure investing. As more investors explore the asset class and the sector looks poised for growth, let's take a look behind the scenes at the rise of infrastructure and what to consider when investing.

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Historical context

Historically, governments primarily funded and managed infrastructure projects such as roads, bridges, airports, and utilities. These assets were seen as public goods, essential for economic development and public welfare, but not necessarily as sources of financial returns. Typically, governments would issue bonds or allocate resources in their budgets to build and maintain infrastructure, viewing them as long-term investments in a region's economic foundation.

Over time, several issues emerged. Governments faced budget constraints and rising public debt, limiting their ability to finance new projects or adequately maintain existing ones. Despite the lack of funding, the need for modern, efficient infrastructure marched on, driven by ongoing replacement needs, urbanization, and technological advancement.

Emergence of private investment

To meet the need for ongoing investments, governments around the world began to explore ways to attract private capital — marking infrastructure's transformation into a distinct asset class. The shift was facilitated by several mechanisms, including public-private partnerships, privatization, and the creation of infrastructure funds.

Public-private partnerships allowed governments to leverage private sector efficiency, innovation, and funding. In a typical arrangement, private firms will finance, build, and operate an infrastructure project for a specified period, receiving payments from the government or consumers. The public-private model provides immediate capital for development and introduces discipline into the management of infrastructure assets.

Privatization, where governments sell existing infrastructure assets to private investors, further highlighted the potential for infrastructure to generate steady, long-term returns. An iconic example includes the privatization of British airports in the 1980s, which demonstrated that these assets could be profitable and attract both investment and return. However, the sale of parking meters in Chicago shows the public casualty of some private investments. Following the 2008 financial crisis, the city needed to close a budget shortfall and sold a 75-year lease on its parking meter system to a private firm. Rather than helping reduce the budget deficit, the terms of the privatization loan created new annual costs for the city.

The growth of dedicated infrastructure funds has also been a crucial driver in establishing infrastructure as an asset class. Funds pool capital from multiple investors to finance a portfolio of infrastructure projects, offering diversified exposure to the sector. Major asset management firms, including BlackRock, Brookfield, and Macquarie, have attracted billions of dollars in investment. Funds invest in a variety of infrastructure sectors, including transportation, energy, communications, and social infrastructure. This diversification within the asset class further helps mitigate sector-specific risks.

Characteristics of the asset class

Several characteristics make infrastructure investments attractive:

• Resilient and predictable cash flows
• Infrastructure assets typically provide essential services with inelastic, ongoing demand, leading to reliable revenue streams across market cycles. For instance, toll roads generate income from steady traffic flows, and utility companies benefit from consistent demand for electricity and water.
• Inflation protection
• Many infrastructure contracts include inflation-linked pricing mechanisms, ensuring that revenues keep pace with rising costs. This makes infrastructure a valuable hedge against inflation.
• Low correlation with other asset classes
• Infrastructure returns often show low correlation with traditional asset classes like equities and bonds. This diversification benefit is particularly appealing during periods of market volatility.
• Long-term investment horizon
• Infrastructure projects usually have long lifespans, matching the investment horizons of institutions seeking to meet long-term liabilities.

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Regulatory and policy support

Government policies and regulatory frameworks have also played a significant role in promoting infrastructure investment. Many countries have implemented policies to facilitate private investment in infrastructure, including tax incentives, regulatory reforms, and the establishment of infrastructure banks.

In the US, for example, the Private Activity Bonds (PAB) program allows private entities to issue tax-exempt bonds to finance public infrastructure projects. The Infrastructure Investment and Jobs Act signed into law on November 15, 2021 doubled the available budget, which increased from $15 billion to $30 billion. Similarly, the European Investment Bank and other multilateral development banks provide funding and risk-sharing mechanisms to encourage private investment in infrastructure.

Challenges and risks

Despite its attractiveness, investing in infrastructure comes with its own set of challenges and risks:

• Construction and operational risks
• Delays and cost overruns during the construction phase can erode expected returns, while operational challenges such as maintenance issues or lower-than-expected usage can affect revenue.
• Environmental, social, and governance (ESG) considerations
• Concrete — a common element in many infrastructure projects — is considered one of the most destructive materials on earth, emitting enormous amounts of carbon dioxide (8% of the world's emissions²) and consuming vast quantities of water. Increasingly, projects must adhere to stringent environmental standards and consider the social impact on local communities. Failure to meet ESG criteria can lead to reputational damage and financial penalties.
• Political and regulatory unknowns
• Political and regulatory risks are prominent since changes in government policies or regulatory frameworks can significantly impact the profitability of infrastructure investments. For instance, a government may decide to place a cap on toll rates or nationalize utilities.
• Lull in new capital rising
• Preqin reports showed a significant slowdown in 2023 capital raising for infrastructure.³ By October 2023, fund managers had raised just $20.9 billion, compared to an average of $136.3 billion annually over the preceding five years. Preqin's analysis raised concerns about uncertainty going into 2024 and the potential impact on growth and valuations.
• Reputational risks
• If we think back to the parking meter example in Chicago, the city made the deal because it needed capital. Yet, only the private investment firm benefitted. Companies making increasingly high-profile deals may run the risk of public backlash and reputational damage. This can impact an investment manager's ESG investment strategy and should be taken into careful consideration depending on the ESG preferences of their investors.

How firms are managing infrastructure investments

Infrastructure as an asset class can be complex from a regulatory, legal, and operational perspective. The illiquid nature of the asset class demands a robust strategy around data management, pricing, investment exits, and more.

Investment firms grappling with vast amounts of data, including incoming files and datasets from order management systems, market data vendors, brokers, and financial market participants, benefit from a flexible security master. Capturing, extracting, and mapping data is often challenging due to inconsistencies in formats and the frequency and volume of data. Infrastructure investments can also be accomplished through private equity deals, private lending transactions, or direct investments in the real assets, each with their own unique requirements for modeling and lifecycle management. With the ability to record deals and derive holdings from those transactions, create user-defined fields to bend the data model around the requirements of each unique infrastructure investment, and flexibly support reconciliations through any vs. any matching, firms can confidently take advantage of the growing asset class.

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Outlook for infrastructure

The outlook for infrastructure as an asset class remains robust. The global need for infrastructure investment is immense, with estimates suggesting that trillions of dollars are required to meet demand over the next few decades.

Technological advancements, such as smart grids, renewable energy, and digital infrastructure, are also creating new investment opportunities. Investors are increasingly focusing on sustainable infrastructure projects that align with global efforts to combat climate change and promote sustainable development.

The rise of infrastructure as an asset class reflects a fundamental shift in how these essential assets are financed and managed. Private capital brings new efficiencies and innovations to help meet the growing demand for modern, reliable infrastructure. While challenges remain, the long-term, stable returns associated with infrastructure investment continue to attract a diverse range of investors, ensuring that infrastructure will remain a key component of the global investment landscape.

Sources

• 1.Infrastructure: An Evolving Asset Class, Goldman Sachs, 2023
• 2.Concrete: the most destructive material on Earth, The Guardian, February 2019
• 3.Preqin 2024 Global Report: Infrastructure, Preqin, December 13, 2023