Inflation Protection and Low Correlation
After a record-breaking year in 2022, fundraising plummeted in the first half of 2023. The first quarter of this year saw the lowest level of infrastructure funding since 2009, with only $8 billion raised compared with $23 billion in 2022.
One factor contributing to the delayed fundraising has been a slowdown in exits and the accompanying delay in delivering money to investors, who are generally unable to commit to new funds due to the uncertainty around the timing of capital returns. Infrastructure debt fundraising has also been difficult. Capital raising in 2023 has dropped significantly and funds closing this year have come to a halt.
Infrastructure is not alone in experiencing a decline in fundraising. Private real estate had its lowest quarter since 2009 in the first quarter, private debt had its lowest quarter in six years, and private equity fundraising was down 20% year on year, according to a report by real assets investment manager Patrizia. Deal activity has veered from its decade-long trend of increasing year on year, with the number of deals and total value of transactions expected to be much lower in 2023, comparable to levels witnessed in 2018.
Renewable energy is the most active transaction sector, accounting for more than 50% of all infrastructure deals in 2023. Greenfield deals have become more appealing to renewables investors, not only because of the higher returns on offer, but also because greenfield assets can offer a solid fit with the climate change theme and can help improve energy security, according to the report.
Connect Money discussed the current market environment with U.S. Energy EVP, Matthew Iak, at the ADISA conference in Las Vegas last month. “There’s an immense about of infrastructure needed surrounding renewables and getting the grid in place. You’re going to see a lot of spending coming from Washington that’s already been approved and you’re going to see a lot of capital going into the U.S. and globally,” Iak said.
Following blockbuster fundraising in 2021 and 2022, infrastructure fund managers accumulated a record amount of dry powder at the end of last year. However, dry powder remains elevated as previously raised funds look for opportunities to invest their resources.
As the global economy becomes increasingly unpredictable, investors will face a number of obstacles. While investors’ recent concerns – valuations, asset competition, and geopolitics – remain top of mind, the impact of rising interest rates is vital. Higher interest rates, like those in other asset classes, can have an impact on asset valuations, refinancing costs and economic activity.
Higher interest rates have severely dented sentiment across all real asset classes. Institutional investors, on the other hand, expect infrastructure to outperform both real estate and private equity in the short to medium term because infrastructure can provide better inflation protection and lower correlation to the public equity market than other real asset classes.
Specific to energy, Iak believes it provides a unique, and ultimately profitable, opportunity. “There’s a super-cycle thesis in place that energy is in the early phases of a long-term bull market.”
As a result, infrastructure commitments are likely to increase when comparing institutional investors’ predicted capital commitments over the next 12 months to the previous 12 months, according to Patrizia. Instead of selecting new managers, investors are favoring existing ties by pursuing ‘re-ups,’ or allocating to follow-up funds managed by current managers, the report added.
Private infrastructure funds are not susceptible to the volatility of public market pricing and may have a steadier intrinsic value because valuations are partially derived from the performance of the underlying assets. Investors may discover that private infrastructure provides a possibility for diversification.
According to research by CAIS, an alternative investment platform for independent financial advisors, the asset class has historically low correlations to both public equities and fixed income at 0.12 and -0.21, respectively, while maintaining a 0.55 correlation to private real estate.
As the relationship between fixed income and public equity returns has been challenged, and real estate valuations suffer in a high interest rate environment, this diversification component is critical to any investment decision.