Evolving market appears set for recovery, albeit under the pressure of higher rates.
The well-documented slowdown showed signs of coming to an end as 2023 drew to a close, with 2024 likely to be a significantly more positive market for fundraising and transactions across the unlisted infrastructure market. The higher interest rate environment has been partially absorbed by the infrastructure asset class to date and we continue to believe there will not be a broad-based repricing event in the market. Total return performance will be under pressure as different infrastructure business types attempt to balance the negative impact of higher risk-free components of their discount rates against what has been a robust period for cash generation. Lower returning equity strategies are comparatively less attractive in this environment, which may drive growing interest in infrastructure debt and higher-returning equity strategies. Given trends in investor allocation decisions, mega-funds will continue to attract capital and many managers will aspire to raise ever larger funds, which should create opportunities for midmarket investors to develop and grow assets to satisfy increasing demand for larger assets.
1 / Macro Update
Forecasts remain changeable. Economic growth is expected to be capped by higher rates and inflation shocks should not be ruled out.
1.1 Interest Rates In Focus
Economic forecasts have altered significantly over the course of 2023. Gross Domestic Product (GDP) growth was more resilient than expected, driven primarily by wage increases and consumer demand, despite the combination of high inflation and interest rates. Another low-growth environment is forecast in 2024, with the spectre of recession in the US, UK and some European markets remaining. Crucially for infrastructure assets with inflation linkage, inflation levels are expected to fall across Europe and the US, meaning there will likely be less of a lift to earnings than was the case in 2023. Coupled with softer demand due to subdued GDP growth and the higher costs of financing for those assets which need to refinance in the short-term, the macroeconomic environment will continue to test infrastructure in 2024. However, overall we expect the market to be more stable than it was in 2023.
Ultimately the pace and scale of interest rate cuts will be crucial to inflation levels, the strength of economic growth, and the performance of the infrastructure asset class. Central banks will need to continue to manage a delicate balancing act to ensure wage growth and economic shocks – such as those seen in events across the Middle East in 2023 – to not revive inflationary pressures, requiring further rate hikes. At the same time, there is growing recognition that in many markets inflation has now fallen faster than expected and economic pressure from high debt servicing costs are painful, with job losses beginning to rise. Cuts to policy rates are currently expected to start in Q2/Q3 2024, although discourse is increasingly shifting to potential earlier cuts. Against this pressure to cut, the Federal Reserve, European Central Bank and Bank of England have all remained steadfast in their communication of the requirement to ensure inflation is fully tamed, making earlier interest rate cuts less likely.
The prospect of rate cuts and a more accommodative long-term interest rate suggests that pressure on long-term assets such as infrastructure should be short lived. There has been significant attention on the increase in the short end of the yield curve, but infrastructure – as a long-dated asset – should in most cases be concerned with the movement of long-term borrowing costs, the movement of which has been significantly less dramatic.