The Road Ahead
As we head into 2024, investors, economists and analysts are debating whether a long-awaited U.S. recession has been avoided or just postponed. For the most part, economic data continues to surprise to the upside. While leading indicators present a more pessimistic view about the prospects of a downshift in economic activity, they, too, have improved.
Still, the current environment is on shaky ground as long as the Federal Reserve perceives inflation as a danger to economic stability and the “higher-for-longer” interest rate environment remains in place for the foreseeable future. The weaker-than-expected October CPI and PPI data released on Tuesday and Wednesday, respectively, is unlikely to deter the FOMC from shifting its tone.
The higher-for-longer scenario indicates greater return dispersion among infrastructure and real estate managers, while private debt benefits from higher rates. According to Partners Group, a private markets investment firm, real estate is still suffering with valuation modifications with value-add strategies being the most appealing segment.
Fundraising activity has clearly slowed in 2023, as many managers have deferred new investments and exits due to rising interest rates and “sticky” inflation. Given fewer payouts from current assets and thus less cash to reinvest, as well as the denominator effect, which limits their capacity to deploy more capital to different investment strategies, institutional money has been harder to attract compared with previous years.
According to Preqin data, private equity funds raised nearly $445 billion in the first half of 2023 across all asset types, a 20.5% decrease from just over $559 billion in the first half of 2022.
One reason may be that allocators are becoming pickier, focusing on long-term management relationships with a proven track record and a large book of business. The comfort of remaining with these managers has enabled GPs to meet their fundraising targets despite market instability. Conversely, this is contributing to longer fundraising cycles, delayed fund launches and changing target fund sizes for smaller and emerging managers.
Good news: Investors anticipate a rebound in fundraising and dealmaking in the first half of 2024, absent a severe recession. Lending activity has recently improved, although capital providers remain extremely picky. Any improvement in credit markets will almost certainly result in the release of record amounts of dry powder, added Partners Group.
This may raise investor interest in infrastructure sectors other than the traditional core renewables of solar and wind, such as offshore wind, distributed generation solar projects, battery storage, hydrogen, biofuels, carbon capture assets, and even forestry.
“Anything having to do with forestry, not just in the US but around the world is going to be strong so I think this product can do well,” J. Carlos Martinez, economist at Crescent Securities Group, Inc, told Connect Money.
Many infrastructure investors are looking at more structured equity offerings to address instability in the debt markets and offer downside protection, helping to narrow the bid/ask gap between buyers and sellers and allowing the seller an option to preserve upside once the market normalizes.
Infrastructure investment has become more decentralized, with the private sector becoming more involved. Corporates and infrastructure funds, for example, are playing a larger role in increasing connectivity by developing fiber networks and data storage facilities, according to a recent report by Macquarie Group, an Australia-based financial services firm with over AUD87 billion ($55.5 billion) in assets.
This broader definition of infrastructure improves the investment climate and opens new channels for cash to be raised and deployed. Despite adverse market conditions, infrastructure demand is expected to rise, and the most successful LPs and GPs will respond to shifting market conditions by being more efficient and collaborative in their allocation and fundraising.