Infrastructure Investing: Q&A with Capital Innovation’s Michael Underhill
Alternative investments may be more volatile than traditional investments, although they frequently have low correlations with or diverge from more conventional asset classes. Investors may find it increasingly difficult to generate sustained income-driven returns and alpha through public markets alone, especially given today’s sticky inflation and higher-for-longer interest rate environment. On both counts, alternative assets are viable options.
We asked Michael Underhill, co-founder and CIO of global alternative assets management firm Capital Innovations, LLC, where he is responsible for overseeing global investment strategies and leading the firm’s Investment Policy Group, about his investment considerations when allocating to the infrastructure sector.
CM: When evaluating a deal, what are you looking for in an investment, and how does infrastructure meet those needs?
Underhill: Capital Innovations believes it can use the Capital innovations Advantage to tackle complexity in sourcing unique opportunities through corporate partnerships and to drive incremental operational improvements that allow us to deliver attractive returns with a relatively low risk profile.
Investing $9.2 billion in infrastructure since 2007 in primaries, secondaries & co-investments across equity and debt provide a unique perspective when evaluating a deal. GP sourcing, screening, asset management and exit track record are all part of an attractive deal. Past performance may not be indicative of future results but that combined with GP alignment of interest provides clarity toward an attractive deal.
Infrastructure meets those needs when we find GPs that are operators with the ability to generate returns through operational improvement rather than financial engineering as we view financial engineering as a “cheap skill set.” GPs that focus their infrastructure investment on middle-market deals can help achieve meaningful returns, while delivering inflation protected income, capital appreciation with a lower correlation to traditional markets investments.
CM: How has the Infrastructure Investment and Jobs Act of 2021 impacted the industry in recent years, and how do you see it continuing to do so?
Underhill: This Bipartisan Infrastructure Deal will take aim at rebuilding America’s roads, bridges and rails, expand access to clean drinking water, ensure every American has access to high-speed internet, as well as tackle the Energy Transition. The IIJA of 2021 created opportunities for pilot projects created additional deal flow across what Capital Innovations calls the three Megatrends: Energy Transition, Digital Transformation & Enhancement of Aging Infrastructure.
The acceleration of investments in these key megatrend areas has created a unique generational opportunity for investors, the golden age of infrastructure investment.
CM: What do you think are the next key steps and targets for decarbonizing infrastructure?
Underhill: Over the past 20 years, the U.S. electric grid has experienced dramatic change. In the early 2000s, there was a rapid shift from coal to natural gas and a move away from highly deregulated business models. In the past decade, there has been rapid adoption of renewables, which have moved to 30% of generation capacity.
Looking forward, we see an attractive investment opportunity set, derisked by the Inflation Reduction Act (which has created incentives for utilities to transition away from fossil fuels to renewables), with potential to transform the earnings growth and shareholder base across utilities, driving potential for stronger multiple premiums over time.
We see a 27% increase in capital investment over the next five years versus the prior five years, which contributes to a 5-year EPS [compound annual growth rate] CAGR of 6%, versus the 10-year average of 4%.
Not only does the demand for infrastructure investment remain high, but it is also expected to be one of the fastest growing segments of private markets: the mismatch between projected investment needs and capital required is expected to grow to $15 trillion by 2040.
There are several long-term structural trends supporting its growth and investment, including expected increase in demand for digital infrastructure to meet communication needs, investment required to fund the energy transition and aging transportation and civil infrastructure will require funding.
Don’t miss the Connect Money: Real Assets Capital Raise event on June 5 in Chicago at the W City Center. Meet infrastructure investing experts like Michael Underhill, founder and CIO, Capital Innovations.
