Many happy returns?
October 31, 2017
Return expectations for infrastructure investments have declined considerably. Is this just a reaction to short-term market factors or does it suggest a more fundamental realignment?
As any institutional fund manager will know, infrastructure rates of return have been on a downwards trend for the last 5-7 years. The factors in play here have been both economic and market-related: from the fall in UK and Eurozone government bond yields, to rising demand for ‘safe haven’ investments, to the increased numbers of investors piling into the sector (not just traditional infrastructure buyers but more mainstream institutional investors such as direct investment pension funds, insurance companies, and sovereign wealth funds). These factors have forced diversification into different asset classes outside of core infrastructure.
In many ways it’s a classic example of supply and demand – with more buyers chasing a limited number of assets, return expectations are bound to fall. It’s no surprise, then, that some of the more experienced investors have been widening their horizons to include non-traditional assets. Between 2007 and 2011 roads, airports, water and energy made up more than 50% of the total number of transactions made by institutional investors, but since then that proportion has dropped to around 30%, with segments like telecom towers and renewables coming into vogue. The latter, in particular, has been buoyed by its predictable cash-flow profile and a supportive regulatory regime.
So where are the return expectations today? We have analysed typical return hurdle rates across categories of core infrastructure assets as shown below. It is interesting to see that while the returns have dropped across all categories, the drop in returns for regulated utilities is sharper. This supports the point around rising demand for ‘safe haven’ assets.
So what’s the outlook from here on?
Our view is that the economic environment is unlikely to change much in the short to medium term. Interest rates are likely to remain low, in historical terms, for the foreseeable future, and the global economic outlook remains uncertain (Brexit being only one example). Likewise, the new classes of investors who are now buying directly into the sector are also likely to stick with these assets for the long term (and in that respect they differ from traditional infrastructure funds which typically have a fixed investment horizon). In a scenario of increasing interest rates, this trend would be expected to be partly reversed. However, the appetite for direct investment by institutional investors in infrastructure assets is expected to remain and underpin deal activity (and thus valuations) in the longer-term.
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