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Infrastructure

Preqin Special Report: The Future of Alternatives in 2027

In this article

Written by Alex Murray, PhD



October 5, 2022


Infrastructure's future is in Europe

Europe will become the center of unlisted infrastructure, with growing risk appetites driving performance in a market-led energy transition

Filling the gaps

Global infrastructure investment is currently lagging where it needs to be. It’s estimated that $23tn investment is required to meet the Sustainable Development Goals by 2030 and stay on the path to net zero by 2050.[1]

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Beyond infrastructure assets’ current and future return, and given their particularly long lives, investments made in them open options to promote growth, aid decarbonization, and deliver social outcomes in the longer term. The role of private capital in helping deliver this investment is crucial, not just because of its ability to mobilize capital for large-scale deployment, but because private models deliver many of the smaller-scale investments in emerging and innovative technology via funds and unlisted developers. As investors strive to meet their own target allocations in the asset class, the next few years will be formative in the longer-term development of infrastructure in alternatives, as it continues to gain ground on real estate and increase its share of the real assets space.


Gaining ground in real assets

Unlisted AUM is forecast to catch up to that of real estate, reaching $1.9tn (Fig. 6.1). This will take AUM in the asset class from 76% of real estate AUM in 2022 to 88% by the end of 2027. The emergence of a tighter monetary environment is expected to bear down on real estate more than infrastructure. Key sectors in real estate, notably offices, face uncertainty from changing work patterns, increasing the risks to terminal values of vast swaths of grade B assets. Infrastructure, however, is riding a wave of politically fed tailwinds in light of the growing pressure to deliver on environmental policies and regain energy independence through the energy transition.
Infrastructure performance is forecast to coalesce at around 11.6% over the 2021-2027 period, down from the 12.7% observed between 2018 and 2021 (Fig. 6.6). While infrastructure vehicles typically achieve higher levels of gearing than in real estate, underpinned by more stable revenues from offtakes or pricing power from monopoly status, a higher-rate environment may constrain the growth of primary infrastructure investment. Favorable government policy and regulatory frameworks will be crucial to delivering the energy transition and providing a grounding for capital to be put to work over the coming years.

Investors flock to commit

Following a stellar first half of the year for infrastructure fundraising[2], the latest Preqin forecast for the future of the asset class anticipates fundraising will begin to temper as it returns to a trend growth path (Fig. 6.8). Fundraising is expected to reach $157bn by 2027, 14% lower than the $182bn forecast for the end of 2022. However, this underplays the trajectory, given the remarkable levels of capital raised in infrastructure in 2022 so far, mainly aimed at North America. By 2023, capital raising will reach $121bn and continue to climb thereafter. The sheer scale of fundraising in H1 2022 made forecasting longer-term capital inflows to the asset class a particular challenge, but several emerging scenarios across global regions discussed below underpin the optimism about the future of the infrastructure asset class.

Biden administration commitments underpin growth in North America

North America-focused infrastructure AUM will climb from $423bn in 2021 to reach $772bn in 2027, delivering a 10.6% CAGR between 2021 and 2027 (Fig. 6.3).
The recent signing of the Inflation Reduction Act[3], alongside the earlier Infrastructure Investment and Jobs Act[4], provides a strong tailwind for unlisted infrastructure in the region, with over $1.8tn of federal funding earmarked for a once-in-a-generation investment program over the coming decade. However, uncertainties remain around how this glut will translate into private capital investment opportunities. 

The growth in core funds in this market will temper as value-added and opportunistic strategies achieve a higher CAGR in AUM between 2021 and 2027 of 13.2%, compared with 8.8% for core and core plus funds. This is credible in a scenario where political commitments translate into de-regulation, and a focus on speeding up permitting lead times makes way for a wave of merchant energy investment. The current high energy prices will likely tempt investors toward taking long-term output price risks, given the favorable costs of renewable technology today.

Core drivers

Influential factors identified by our in-house modeling suggests core infrastructure performance in North America is correlated with real, disposable income. With inflation expected to remain high, we might see some downward pressure on performance as real incomes are constrained. However, given that much of the inflation is driven by surging energy prices and the subsequent abnormally high profits for energy companies, some infrastructure investors in private markets will benefit from the energy squeeze. Those that can avoid inflation drivers on the cost side of the business, such as solar and wind generators, usually benefit the most, as profitability is rising off the back of heightened prices for hydrocarbons through wholesale electricity markets.

Performance in the region is forecast to average 9.2% per year, slightly less than the 10.3% achieved in North America between 2018 and 2021 (Fig. 6.6). Core funds are forecast to achieve a significantly lower 8.3% average annual return over the period, reflecting the lower risk profile of these funds in the region. These lower risk infrastructure equity deployments are often achieved through investment into highly regulated companies, with the regulatory framework setting the risk/reward exposure.
The recent leap in regulatory attention to the role of broader private equity in industrial ownership[5] presents a potential downside risk for other alternative asset classes. Regulators of infrastructure sectors will have to grapple with the inherent natural monopoly characteristics of some assets and networks. Any attempts to mimic the tighter controls of concentrated sectors could risk constraining capital flows toward the delivery of the energy transition in line with the political ambitions of the Biden administration in North America.


Conflicting scenarios: public vs. private delivery

The emerging economic slowdown presents a downside risk to infrastructure fundraising in North America, which is set to decline from a forecast $114bn in 2022 to $52bn in 2027. This more tempered fundraising will help keep dry powder from rising too high in the region, which is expected to reduce from 31.6% of AUM in 2021 to 27.5% in 2027.

That said, this is highly dependent on how recent political commitments translate into opportunities for private capital deployment. If governments seek to utilize infrastructure investment through traditional government financing in existing assets to deliver fiscal stimulus, private capital models may be sidelined. This aligns with the reality that most existing stock of North American infrastructure remains in public hands. Much was made of the potential for such stimulus policies during the global pandemic[6], but as supply chains began to tighten, the demand-pull inflationary effects of such policies have become harder to justify in the short term. In the medium term, however, if inflation persists in a recessionary environment, governments may once again consider different options. Private capital must be ready to offer faster routes to deployment to take advantage.


European problems, private capital solutions

Meanwhile, Europe-focused infrastructure AUM is set to see the fastest growth rate of all the major global regions, with a CAGR of 17.8% over the 2021-2027 period, reaching $882bn, significantly higher than the $331bn recorded in 2021. While this is a slowdown on the 22.9% CAGR seen over the 2018-2021 period, analysis suggests capital targeting the region will continue to be deployed effectively, with the share of AUM taken by dry powder forecast to remain steady from 29.4% in 2021 to 29.9% by 2027. European AUM is forecast to overtake that of North America by 2025, driven by a recent uptick in fundraising in 2021 and the increasingly pressing need to achieve energy independence.

The region currently finds itself in the grip of an increasingly critical energy shortage with supplies from Russia being dialed down in response to Russia’s invasion of Ukraine. Decades of perceived energy security in the region, despite reliance on Russian imports, have subsequently been shattered. This is triggering a reluctant acceptance of the continent’s need to rapidly develop its own energy independence, even if it means reliance on a more globally diverse supply base. However, ramping up energy generation can't rely on carbon-intensive sources in the long run if the ambitions to reduce emissions are to remain credible. Renewable energy in Europe will see a long-term push that will provide a cornerstone to the growth of the infrastructure asset class globally.


Energy needs may trump ESG commitments in the short term

In support of this AUM growth, capital raising targeting Europe is forecast to see a steady increase from $54bn in 2022 to $86bn in 2027. Investors can see clearly that opportunities for deployment across the continent will improve, as the political necessity to avoid longer term energy constraints will lead to an easier deployment environment. The recent attempts to expand LNG (Liquefied Natural Gas) storage capacity to facilitate shipments from further afield markets face short-run constraints[7]. However, beyond this timeline, there is growing opportunity within this sector to absorb current dry powder and future commitments. While gas power may not pass some ESG screening processes, there will be many more willing to invest in this essential source of baseload energy generation. Analysis of the share of energy-focused fundraising looking to deploy into more carbon intensive conventional energy focused funds shows an uptick in 2022[8], reversing five years of displacement by renewables-focused fundraising. This presents the first major test of investor ESG commitments in private infrastructure markets.


Energy fundamentals drive merchant opportunities

A stronger growth in value added and opportunistic strategies in Europe-focused capital compared with North America aligns with the higher forecast performance for the region as a whole of 13.3%, above that forecast for North American-focused capital (9.2%). This is a dial down from the 14.5% annual performance observed in Europe between 2018 and 2021. Value added and opportunistic strategies across Europe are forecast to return 18.3% over the forecast horizon, given the higher risk exposure of these funds. This growth of value-added capital looking for deployment in Europe aligns well with an energy transition that embraces more merchant models, considering anticipated longer-term high energy prices. These models, free of government support policies, can deliver the scale of investment needed to achieve greater energy independence.


Market solutions to political problems

Pursuit of such investments are only possible with the emergence of two key cash flow drivers: lower production costs, with solar having fallen by 85% between 2010
and 2020[9], and higher energy prices, with one-year forward baseload power in Europe over 10 times what would be considered a high price before 2021. While the uncertainty around longer-term energy prices may cause hesitation around the scale of their commitments in the short term, the emergence of grid scale battery technology, most active in the UK so far[10], provides another innovative sector to absorb capital and help alleviate future spikes in spot prices. But for this scenario to occur, European administrations must make efforts to speed up the planning and permitting of new greenfield projects.


Markets elsewhere: APAC and RoW remain fledgling destinations

Beyond these established regions for infrastructure capital focus, the prospects for growth in APAC and Rest of World are less certain. Their emergence as regions within the asset class means forecasting their development is subject to greater risk and uncertainties around developing the alternative asset classes. To add to this complexity, the emergence of diversified multi-regional strategies creates another dimension. Alongside APAC- and RoW-focused capital though, these combined only accounted for 15% of global infrastructure AUM in 2021. This is set to decrease to 12% by 2027, as AUM across the three areas of capital focus increases from $134bn to $224bn. The Rest of World CAGR over the period is expected to be just 3.2%, reflecting the need for strong institutions and low political risk for unlisted infrastructure models to prosper. Fundraising across APAC and Rest of World will keep pace with anticipated growth in North America and Europe at a 5% CAGR of the forecast horizon. However, diversified multi-regional fundraising is forecast to contract at a -4% CAGR between 2021 and 2027, meaning the AUM growth seen within these funds is driven by the highest level of annual returns of any aggregate region at 17.5% (Fig. 6.6).





Private models increasingly central to energy transition

Despite the emergence of a tighter monetary environment, the underlying demand for investment in infrastructure will underpin the continued growth of the asset class in the coming years. The heightened inflation driving the need to dampen demand serves to add to the attractiveness for investor allocations to infrastructure, given the inflation hedge that many infrastructure investment models provide. However, as the energy transition progresses, the generosity of government subsidy schemes in developed markets is waning. This demands more infrastructure investment in the energy sector facing market pricing risk or finding offtakes from corporate power purchase agreements. Regardless, private infrastructure investment models are at the forefront of scaling up renewables capacity across the globe.