Private infrastructure: a new era for long-term investing

Over the past decade, private infrastructure has become one of the fastest-growing asset classes among institutional investors, with assets under management (AUM) rising by more than 15% per year.¹ Until recently, most of the fundraising had been in closed-end private equity structures. However, over the last three years, the number of open-ended funds has more than doubled. What accounts for the change, and what are the merits of open-ended and closed-end structures?

The history of private infrastructure as an asset class

In 1992, the Australian government overhauled the country's pension system, introducing mandatory occupational pensions as part of a new Superannuation Guarantee, which today has approximately $2.4tn in assets. During the same period, Australia's federal and state governments began privatizing a range of public sector assets, including airports, toll roads, and electrical systems. The new Superannuation funds were eager to participate and acquire assets whose profiles of essential services with long-term, monopoly-like cash flows were a good match for the pension system's long-dated liabilities.

By the early 2000s, other governments globally had launched their own privatization programs, opening new opportunities for private investment in infrastructure. As the supply of projects increased, large institutional investors began investing directly in the asset class, drawn by its benefits as a source of inflation protection, the excess returns, and improved diversification.

Mid-sized institutional investors took note. Lacking the scale to invest directly in infrastructure assets, they sought fund-based solutions. In response, private equity firms introduced infrastructure funds with the characteristics of traditional private equity funds.

With infrastructure a mainstay in large and mid-sized institutional portfolios, over the past five years, smaller institutions and individuals have been seeking access to the asset class. Critics of closed-end infrastructure funds cite the higher implementation costs of managing multiple funds and vintages, as well as the mismatch between the fund structure, the long-term monopoly-like cash flows from essential assets, and an investor's longer-term time horizon.

Open-ended structures

What exactly is an open-ended fund? It's an investment structure that has no defined end date, similar to traditional bond or equity funds perpetually open to new investors and to new investment from existing investors, while offering regular liquidity for investor redemptions, income needs, and rebalancing. To facilitate this, it includes liquidity provisions to enable investors to redeem capital when needed. By contrast, closed-end funds raise capital in a blind pool over a specified period, and then close the fund to new investment. The capital is locked up until the end of the fund's life, at which time it is automatically returned to investors.

Proponents of open-ended funds highlight the natural fit between the multi-decade cash flows of an infrastructure project and the long-term objectives of investors. In addition, the client experience is very different. This is reflected in a smoother path of capital, as investors can access a known pool of investments and rebalance their allocation over time. Rebalancing a portfolio is one of the more powerful tools for achieving long-term goals and better risk-adjusted returns. In a closed-end fund, investors typically can't access their capital until the end of the fund's life. This creates a non-linear path for their capital, requiring investment in a series of closed-end funds or vintages to maintain the desired allocation. The result is greater capital friction and higher implementation costs.

Opportunity for growth

Institutional investors have long invested in open-ended funds within public equity, fixed income, and private real estate. Infrastructure funds have remained the outlier, having had their debut through private equity firms with mid-sized investment organizations accustomed to the closed-end structure typical in the private equity space. However, as infrastructure continues to demonstrate its value in a balanced portfolio, demand has grown among smaller institutions and investors, for whom the cost and complexity of closed-end structures are an impediment.

With the democratization of access to private market strategies, a new set of investment vehicles has emerged, including a raft of open-ended infrastructure funds. Prior to 2018, only a handful of such funds existed. The landscape has now shifted, with an explosion of open-ended options.

Open-ended structures have focused on two areas of the market. The first group are core or super-core strategies, which emphasize lower-risk operational assets, and TD Asset Management Inc. estimates delivered returns in the 6–8% range. Often marketed as a replacement for fixed income, these strategies were an attractive alternative in a world of near-zero interest rates. However, with traditional fixed-income funds yielding an estimated 5–7%, the risk-reward trade-off for core or super-core assets has been brought into question.²

The second group is core-plus strategies. These funds incorporate core assets and asset improvements or new development with an aim to achieve higher return targets in the 8–12% range.² Proponents of these strategies point out the ability to act strategically and invest for the long-term. Freed of the artificial time pressure imposed by closed-end funds, they can evaluate investments over an asset's lifecycle and allocate the time needed for development projects, where permitting – land acquisition, design, and construction can take years. The result is often stronger income growth for investors over time.

While the discourse around the relative merits of open-ended and closed-end funds will continue, one thing is certain: investors have more options than ever. Whether they select a single, open-ended manager for their entire allocation or assemble a portfolio of multiple open-ended and closed-end managers, the opportunities available to help them meet their goals have never been better.

About
TD Global Investment Solutions (TDGIS) represents the institutional asset management businesses of TD Bank Group (TD) – TD Asset Management Inc. (TDAM) and Epoch Investment Partners, Inc. (TD Epoch). Both entities are affiliates and wholly owned subsidiaries of The Toronto-Dominion Bank. For more information, visit www.tdgis.com.

_{1 Preqin Data. As of December 31, 2023
2 Source: TD Asset Management Inc.}