US-based LP consultant Verus Investments sees strategies targeting the mid-market as “our highest conviction” in the asset class, according to its latest real assets outlook.
Non-core infrastructure was the only part of the asset class it had a ‘positive’ outlook on, with energy transition remaining ‘neutral’ and core infrastructure rising from ‘negative’ to ‘neutral’ from last year’s report.
Within this, it wrote: “Non-core infrastructure comes with higher operational/execution risk than core, therefore investors should expect a broader range of outcomes and greater emphasis on manager selection. We prefer a rifle-shot approach with managers who have a robust track record and deep experience in a market niche. Strategies targeting assets in the middle market, building the infrastructure of tomorrow remain our highest conviction.”
However, as John Nicolini, Verus managing director and leader of its real assets division, told Infrastructure Investor, the adviser would like to see more players in this field.
“Fundraising within infrastructure is largely concentrated around five to seven managers and that’s not healthy for the asset class,” he said. “You need a bench of lower and middle market infrastructure managers out there and we just don’t have many of them.”
Nicolini added: “Once you get into that large-cap segment of infrastructure, it’s crowded because that’s where all the money’s been raised and that’s where they’re all competing for deals. It seems to me there’s an opportunity and that $50 million to $150 million equity cheque, that is overlooked or is less competitive because all the money is being raised by $15 billion and $20 billion funds. The challenge is actually finding managers who are skilled and have a track record they’re actually executing in that part of the market.”
Some large-cap managers have sought to fill that gap themselves, with Antin Infrastructure Partners raising €2.2 billion in June 2021 for its Antin Infrastructure Partners Mid Cap I vehicle, while Stonepeak is also thought to be nearing a final close on its mid-market Stonepeak Opportunities Fund, targeting $2.5 billion.
Verus also said that “the blurring line” between infrastructure funds and buyouts “is a troubling trend for an asset class that is meant to offer stable returns”. Nicolini highlighted asset-light deals and service-oriented businesses in the value-add space as particular examples of this.
“When you’ve got a fund that’s, in essence, doing what a buyout fund is doing, you’re not really getting anything different,” he argued. “You’re basically doubling down on buyouts, in our opinion. If you’re not really getting the infrastructure asset class sets of returns, what’s the point of it?”
Battling against the tide
In its outlook last year, Verus said it was recommending clients to hold off on commitments to core infrastructure funds amid the effect of rising interest rates on this segment of the asset class. While Nicolini said “we’re not excited” about core in 2024 and that valuations remain “stretched”, it raised the outlook for core infrastructure from ‘negative’ to ‘neutral’.
“We thought that we would see pricing pressure, much as you saw on real estate, and we anticipated there would be some write-downs in the latter part of 2023, maybe early part of this year. We haven’t seen much in the way of changes on valuations,” said Nicolini. “It seems as though the asset class may end up riding through this high interest rate environment, which pushed us to be more neutral on it.”
Despite this, Verus said in the outlook report that it sees lower returns for core infrastructure while financing costs maintain pressure. Partially as a result of this, some core funds are looking for higher returning assets, with KKR’s global head of infrastructure Raj Agrawal telling Infrastructure Investor in April that the economic climate may provide an opportunity to “step into a better return profile” for its core fund. Infrastructure Investor also reported in May that Global Infrastructure Partners is engaging with LPs on increasing the target return for its core fund. Nicolini, though, has reservations that core infrastructure can reach historical returns while rates remain high.
“If we’re not getting multiple expansion and cost of debt is higher, how are you going to get these high single, low double-digit returns that you’ve seen the asset class deliver over the last 10 years?” he questioned. “I think that’s what’s underlying our hesitancy to go positive, because we don’t see how the asset class can deliver the kinds of returns it has historically, if multiples have really been unchanged.”