Unlisted Infrastructure: Appetite and Prices on the Rise

Over recent years, the alternative assets industry has grown in both size and prominence, with many investors making increased allocations to private capital and hedge funds.  While the unlisted infrastructure fund market is relatively small in comparison to more established alternative asset classes, such as private equity and real estate, the market is growing.  Assets under management now stand at $298bn, and the level of capital available to fund managers (“dry powder”) has reached an all-time high of $115bn.  However, with increasing numbers of investors being attracted by the risk/return profile of the industry, this level of funding is creating its own set of challenges for infrastructure firms looking to put capital to work.
 
The long-term nature and downside risk protection brought about by the inflation-hedging attributes of the asset class has made infrastructure attractive to investors seeking relatively stable returns over a long-term investment horizon.  Over three-quarters (77%) of respondents to Preqin’s latest study of institutional investors stated that the performance of their infrastructure fund investments over 2015 had met or exceeded their expectations.  Furthermore, appetite for the asset class is high among institutional investors: 74% stated that they intend to invest either more or the same amount of capital in infrastructure over the next year than in the past 12 months, and 52% intend to increase their allocation to infrastructure in the longer term.  With the majority of investors currently below their target allocation to infrastructure, capital should flow into the asset class over 2016 and beyond.
 
This continued enthusiasm for infrastructure has partly been driven by recent record levels of distributions from fund managers to investors; unlisted infrastructure funds distributed $34bn back to investors in 2014, and a further $22bn in the first half of 2015.  In fact, the first three months of 2015 saw more capital distributed to LPs than the whole of 2010.  As distributions increase, previously tied-up capital is released back to investors, which are then able to re-invest this capital.  Consequently, fundraising looks set to remain strong in the coming months as investors seek to plough capital back into the asset class.
 
Certainly, unlisted infrastructure funds are seeing increased interest from LPs, with 74% of fund managers stating in Preqin’s most recent survey that they are seeing greater appetite from investors.  However, as new players have entered the unlisted infrastructure space, the fundraising market remains a challenging place to secure commitments.  The market is more crowded than ever before, with 181 unlisted infrastructure funds seeking a combined $125bn in institutional investor commitments at the start of 2016.  This is far more than the 42 infrastructure funds that closed in 2015, which raised an aggregate $33bn.  With such a large number of funds on the road, and relatively few reaching a final close each year, fund managers are spending a long time marketing their funds.  22% of the infrastructure funds in market have been raising capital for more than two years.
 
Furthermore, the increased amount of capital in the fundraising market seems to be concentrated among a smaller number of well-established fund managers with proven track records.  Over half (58%) of the total capital raised for unlisted infrastructure vehicles in 2015 was secured by only five funds, including sizeable offerings from ArcLight Capital Partners, KKR and I Squared Capital.  Of the funds currently being marketed to investors, two are targeting $12.5bn each, and if they meet their targets at close they will be the largest unlisted infrastructure funds ever.  Investors are placing their faith in the deal-sourcing capabilities of the largest players in the industry, and the proportion of investors which will not invest in first-time funds (44%) is for the first time higher than the proportion which will (42%).
 
The buoyancy of the fundraising market means that managers have record amounts of capital available for investment.  As a result of this competition, valuations for infrastructure assets have increased, driving the average deal size to an all-time high of $532m in 2015, as managers vie for the most attractive opportunities.  However, this growth has not been completely linear across the industry; transactions in more developed infrastructure markets like North America and Europe have seen the largest increases in average deal value.  Meanwhile, investor appetite for the favourable characteristics of brownfield sites has driven prices for these assets up at a faster rate than infrastructure at both the greenfield and secondary stages. 
 
Most fund managers are confident they can put sizeable amounts of capital to work in the coming year: over three-quarters (77%) of surveyed fund managers plan to deploy more capital in infrastructure assets in 2016 than they did in 2015.  But despite this confidence, competitive pricing is clearly making sourcing deals a difficult prospect for many firms; the majority of fund managers (52%) named finding attractive investment opportunities as the biggest single issue affecting their business. 
 
Overall, while the demand for private capital in the infrastructure space will only increase over time, due to the significant gaps in government budgets to actively replace ageing infrastructure or construct new projects, some investors may be concerned that capital committed now may not deliver the strong, stable returns to which they have become accustomed.  It remains to be seen whether today’s asset prices will have an adverse effect on the overall performance of unlisted infrastructure funds currently investing capital, and investors face the challenge of identifying the managers that can truly deliver the returns they seek within an intensely competitive fundraising market.  However, record distributions, rising appetite and the large proportion of investors under-weighted to the asset class should see a continuation of the strong fundraising figures seen in recent years.
 
Andrew Moylan is Head of Real Assets Products at Preqin, overseeingthe overall commercial strategy of Preqin’s real estate and infrastructure products, developing and promoting online products, producing and editing real assets focused publications, and managing other strategic initiatives. 
 
Preqin is the alternative assets industry’s leading source of data and intelligence, covering private capital and hedge funds.  For more information, please visit www.preqin.com/guide

Andrew can be contacted on +44 (0)20 3207 0200 or by email at info@preqin.com