Why invest in brownfield infrastructure?
Brownfield infrastructure is infrastructure that is already in place and operational. Owners may capture reliable, secure, typically inflation-linked cashflows over long investment horizons as well as benefiting from capital growth, while helping deliver essential services for the public good. Unlisted infrastructure equity is considered illiquid, and thus carries the associated risks to capital invested as well as other risks that can adversely affect values. However, it has the potential to offer attractive returns with low correlation to other asset classes, providing an effective portfolio diversifier.
The developing landscape of infrastructure investing
We believe infrastructure equity remains an attractive asset class for investors worldwide and investment continues to grow steadily. Flows into the sector are increasingly concentrated in a small pool of mega funds, which in some cases have raised in excess of $10 billion of capital.
However, the largest funds typically focus on big-ticket transactions, those in excess of $1 billion. These deals tend to be high profile, headline-making opportunities, often referred to as trophy assets, such as international airports. Big-ticket, trophy transactions are frequently the most publicised but are limited in number, meaning that high competition for these assets pushes pricing up and, in turn, expected IRRs down, to levels that might only appeal to investors with very low costs of capital.
The largest funds and direct investors do not typically look to the mid-market – deals smaller than $1 billion – for assets. As a result, competition is reduced for mid-market assets. However it is in the mid-market where the majority of deal volume is taking place.
The mid-market – under the radar
Across Europe, we believe that mid-size infrastructure assets benefit from a supply/demand imbalance, providing compelling investment opportunities for selective investors.
There is potential for specialist investment managers to use their experience and extensive relationship networks to target and source opportunities bilaterally or to secure non-price advantages in a more competed process. These may be complex opportunities or where the asset needs to be created (e.g. a business spun out of a larger company) or because a vendor has specific requirements or objectives. In these mid-market circumstances, competition for assets is reduced and pricing more attractive.
Of the nearly €65 billion (approximately $68 billion) capital that was raised in 2016, barely 5% (€3.4 billion) was destined for the European mid-market. Where larger transactions have faced upward pricing pressure from the weight of demand, it is possible to avoid such excessive competition across the broader mid-market sector.
Brownfield – Opportunities in many hues
There is an extensive requirement for expanding, strengthening and reinvigorating the existing infrastructure base, which results in a broad scope of brownfield sector opportunities for investors to participate in.
Opportunities are often found in a number of traditional sectors, such as utilities, transport, telecoms and renewables.
Astute investment in the brownfield market can generate attractive returns for long-term investors both in terms of income generated and in total returns, particularly where employing a specialist manager, such as Infracapital. Prospective investors should be aware that investment in infrastructure carries risks common to other illiquid investments as well as risks unique to itself. Having the ability to call upon wide-ranging expertise in securing attractive complex opportunities, usually on a bilateral basis, and supplementing that with a strong asset management capability and track record may be instrumental in minimising those risks.
Sourcing opportunities and building value
We believe some of the most attractive opportunities in the mid-market can be sourced by reaching bilateral agreements, often for assets that are off-market. They may be most successfully achieved by capitalising on the strengths of a broad existing network of relationships, avoiding the more competitive auction processes, common to such transactions.
A focus on complex brownfield deals, which require experience, relationships and specialist expertise, can unlock considerable value.
Active ownership and proactive exit
Sourcing and acquiring assets reflects only part of the process of unlocking value from brownfield infrastructure. We believe having dedicated asset managers with commercial and operational expertise is critical in delivering value to investors. They identify opportunities to improve efficiency and customer service within portfolio companies, seeking to optimise performance, enhance profitability and ultimately, exit value.
Raising the standards of a business to best practice can be a further source of value. Growth is likely to be most sustainable when an active owner can strengthen ESG standards, enhance health and safety practices and build positive stakeholder relationships.
Experienced asset managers can also oversee complex business turnaround situations and drive growth strategies. One way to achieve that is to adopt a platform approach that gradually builds scale and value over time.
Asset managers should adopt a practical and pragmatic approach to exiting investments in order to deliver best value to investors.
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For further information about Infracapital, the infrastructure equity investment arm of M&G Investments, please visit www.infracapital.co.uk.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Wherever past performance is shown, please note that this is not a guide to future performance.