Infrastructure has been stimulating increased interest among pension funds in the past decade, with a growing number ramping up their allocation to the asset class. While robust demand is translating into higher prices and commensurately lower yields, brownfield infrastructure opportunities, in the mid-market particularly, has the potential to deliver solid value and compelling returns for long-term investors.
For institutional investors, owning infrastructure assets holds some obvious attractions: there’s the potential to benefit from capital growth, as well as from stable, secure, typically inflation-linked cashflows over long investment horizons. And then there’s infrastructure’s potential to act as a powerful portfolio diversifier, delivering attractive returns with a low correlation to other asset classes. Alongside its attractions, unlisted infrastructure is considered illiquid, so carries the associated risks to capital invested.
Private investment continues to expand its interest in infrastructure
Robust flows into the sector, resulting from buoyant fundraising activity has helped to create a deep pool of capital standing ready to be deployed, also known as dry powder. This has created fierce competition for assets. However, the well-known larger funds and direct investors tend to focus on big-ticket infrastructure transactions valued in excess of US$1bn – often the high-profile, headline-grabbing opportunities, such as international airports, sometimes known as ‘trophy assets’.
There are a number of smaller opportunities that offer the same infrastructure attributes and are less keenly sought after. We believe this mid-market space, which accounts for the bulk of deal volume across Europe, marks the sweet spot for infrastructure transactions, given the lower competition and significant potential for value creation. In the brownfield sector value can be both created and unlocked from a combination of strengthening, updating and reinvigorating what is already in place. Investors should appreciate that investing in infrastructure does still carry risks. As well as being illiquid the asset class faces risks unique to itself.
Accessing the best brownfield opportunities takes specialist skills
As investor demand has escalated, prices for brownfield assets have been driven up, meaning the yields they offer have been forced down. For institutional investors targeting long-term value, we believe that some of the most attractive opportunities can best be sourced by managers with the relationships and expertise to
negotiate agreements mutually with the sellers, such that assets are not offered to the broader market.
Experienced managers are well positioned to successfully achieve this by capitalising on their broad existing network of relationships, which enables them to avoid the more competitive auction processes that are typically a feature of this type of transaction. And it’s an approach that can come with several benefits for investors.
As well as offering an intuitive way to sidestep overly competed assets, this approach often frees up more time for managers to carry out comprehensive, focused due diligence for complex investments. It also allows them to promote the strengths they possess beyond the price offered, such as deliverability and suitability as an owner or future partner.
In addition, vendors of brownfield assets often prefer to work with a single party, enabling them to cut out the expense, time and resource commitments of managing a competitive bid process from start to finish.
An active approach to creating maximum value
A further way to create value for clients from infrastructure investment is by adopting an active management approach. This allows managers to work the assets to their full potential, whether it’s by reshaping a company, bringing in new management, changing the culture or raising standards to best practice.
All long-term investments face the risks that arise from unforeseen events. However, when it comes to unlocking the value from brownfield infrastructure, sourcing and acquiring assets may be just the tip of the iceberg. For investors, we believe the greatest value comes from having dedicated asset managers who are skilled at identifying opportunities to improve efficiency and customer service within portfolio companies, enhance profitability and, crucially, maximise exit value.
Martin Lennon, head of infracapital, M&G Investments
Column sponsored and supplied by M&G Investments
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