Infrastructure funds are victims of their own success. Unlisted funds had over $373 billion of assets under management at the end of June 2016, up from only $24 billion in 2005.1 In addition, sovereign wealth funds and pension funds are increasingly investing directly in infrastructure themselves. The number of traditional infrastructure assets isn't keeping up with this investor demand - there are only so many regulated assets in developed markets. With more and more money chasing the same type of assets, valuations are high and deal win rates are low.
In their search for attractive returns, we expect investors to tackle a broader range of opportunities and risks: developing markets, with greater country-level and regulatory risks; greenfield projects, with development and construction risks; and 'core plus' infrastructure (businesses that are halfway between traditional infrastructure and private equity) with greater market and operational risks. This transition from pure-play, low risk infrastructure requires new skill sets and capabilities in deal sourcing, evaluation and asset management.
In developing markets, multilateral development banks such as the World Bank are working to help private capital reach the right infrastructure opportunities.
1 Source: Preqin
New leaders in the U.K. and the U.S. have indicated increased infrastructure spending. Elections in 2017 may do the same in France and Germany. Beyond the planned growth in funding, many governments are also approaching infrastructure spending from a new angle, as a tool to help “spread the wealth.” As a result, besides projects such as roads and ports that primarily aim to boost productivity and growth, we’re also likely to see more social infrastructure with a primary goal of improving citizens’ quality of life: hospitals, schools, and public amenities.
Ambitious infrastructure goals bring new challenges for policymakers. The promised spending will likely run up against budgetary constraints, and, even with the influx of private capital, there may not be enough to meet needs. For example in the US, Trump's $1 trillion investment in infrastructure is already facing congressional scrutiny. And to execute on their promises, governments will need new human resources and risk management capabilities. Politicians need to be wary of promoting superfluous or vanity projects for political gain, as the international infrastructure landscape is littered with projects that were not needed or over-specified and for which the tax payer continues to pay the bill.
Governments and investors alike typically expect an infrastructure asset to last thirty years or more. But the megatrends transforming our planet – rapid urbanisation, climate change, shifts in global economic power, demographic changes, and technological breakthroughs – can cause even traditional assets to lose relevance quickly. What will happen to an electricity transmission company’s investments if smart batteries and rooftop solar panels cut usage? What might climate change do to infrastructure built close to sea level and to hydroelectric plants dependent on rainfall?
As a consequence of these megatrends, infrastructure, traditionally a conservative asset class, now faces new risks. To future-proof their infrastructure spending, governments and investors will need new assessments and skills to prepare for emerging opportunities and challenges. For example, the Internet of Things (IoT) will likely lead to the rapid build-out of high-speed national communications infrastructure, and to growth in distributed and connected power generation. Connected homes may generate part of their power and optimise consumption through low night tariffs and home storage, requiring utilities to develop and execute on new strategies.
There’s a growing push to decarbonise economies, use green construction methods, and make cities ecologically sustainable. The 2015 Paris climate agreement known as COP 21 established ambitious goals to fight global warming. The UN’s 2016 Habitat III conference established a new urban agenda for sustainable development. Yet conflicts are arising between hopes for a green future and concerns about the costs. Even Germany is slowing the pace of its transition to renewable energy because of the expense.
This conflict is particularly apparent in countries where the pressure from the urbanisation megatrend is enormous: worldwide, 1.5 million people move to cities each week. This population shift makes urban infrastructure spending a necessity, even in countries like China that already have strong basic infrastructure. But which urbanisation model will these growing cities adopt, greater density or growing sprawl? Will they prioritise short-term cost savings or the longer-term benefits that sustainable development will bring? The answers will vary by country.
Countries rich in natural resources have suffered from the fall in commodity prices, with government budgets taking a hit. However many of these countries’ leaders see infrastructure as a way to maintain growth, support vulnerable sectors of the population, and eventually transition away from commodity-dependent growth models. Therefore governments are having to consider innovative private financing options and turning to the private sector to support these plans.
Some countries are moving toward structural reforms and new financing strategies. Brazil is planning to streamline regulations to attract private investors to ports and roads. Saudi Arabia is expected to expand privatisations and the use of PPPs, with the latter a priority for telecoms and IT. Whilst all of this is positive for the development of much needed infrastructure, the challenge remains as to who ultimately will pay for it: the user or the tax-payer?
These five themes all have rapid change in common. Yesterday’s strategies are no longer enough to tackle tomorrow’s challenges. But with the right mix of agile strategies, investors and governments can together meet the needs for affordable, sustainable infrastructure.