We are witnessing a period of broad-based economic and geopolitical concerns. Global central banks are attempting to perform a delicate balancing act of maintaining interest rates at elevated levels long enough to contain inflation, without inflicting significant economic damage.
With this backdrop, infrastructure continues to be a key private market asset class that offers investors clear diversification benefits and lower correlations to their existing equity and bond portfolios. Infrastructure has been somewhat shielded from the impact of high rates by its ability to pass through inflation and so investors have not seen a material fall in unlisted valuations.
"These businesses can often absorb inflation into their cash flows and this inflation-proofing ability has really offset the potential negative effects of higher interest rates," says Justin Webb, Head of Investment Solutions, PATRIZIA. "However importantly, not all infrastructure assets are created equally when it comes to inflation protection. The inflation proofing of an investment is affected by many factors ranging from the level to which inflation can be passed through to end users, the company's EBITDA margin, through to the elasticity of demand to absorb these higher costs," explains Webb.
Furthermore, in infrastructure, the spectrum is wide and not only sector-specific, but asset-specific. While a sluggish economy means that Gross Domestic Product-linked assets could struggle, assets driven by mega-trends could continue to find support.
"We currently favour assets that have more long-term structural drivers and are linked to the thematic trends of decarbonisation and digitalisation. We are leaning away from assets that are linked to what is happening in the broader economy, such as ports, airports, and toll roads," he says.
Investors that have an existing allocation to large-cap infrastructure can find clear benefits by utilising a mid-market manager in the portfolio. Empirical evidence suggests that the inclusion of a mid-market manager results in not only higher returning portfolios on average, but importantly, a combination of a large-cap and a mid-market infrastructure manager produces more favourable risk-adjusted returns.
Webb notes "However, like any investment decision, the devil is in the detail and the manager selection process within the mid-market space is vital, given there exists a broad variance in performance results of mid-market managers over the last decade."
"It goes without saying that the selected manager should have a proven track record within the mid-market space, and one who you feel confident will make investments into geographies and industries most varied to a client's incumbent large-cap manager to provide the greatest level of diversification" says Webb.
Webb finally points out "When it comes to the type of transactions on offer, if you look at the opportunity set, mid-market deals have really taken advantage of the mega trends in greenfield digital infrastructure and the energy transition - whereas, while large cap transactions have included some prominent telecommunication transactions and data centres, they still do largely centre around brownfield base load energy such in oil and gas as well as the traditional large-scale assets, such as major utilities, airports, rail, and roads. As investor sophistication grows in Europe, investors will look towards mid-market managers more rather than a large-cap ‘one size fits all' approach, often with more focussed strategies."
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