Unpacking opportunities in infrastructure

Infrastructure may be the asset that Canadian pension funds have differentiated themselves with most. From the early onset of maple eight investing, this subcategory of alternatives introduced novel sources of returns, stability, and non-correlation that asset managers around the world are seeking to emulate.

Brent Burnett, head of infrastructure and real assets at Hamilton Lane, recently spoke with BPM about the current market for infrastructure assets. He explained how today’s interest rate environment impacts the outlook, and highlighted where he sees particular opportunity in infrastructure assets, in part by looking at where institutions aren’t allocating capital yet.

“We continue to see institutions under-allocated to the small to mid-market space,” says Burnett, “If you look at the fundraising within infrastructure, it’s still disproportionately concentrated in the large 10+ billion dollar market. In contrast, if you look at the transaction market, over 80 per cent of the transaction market is driven by assets that are sub $1 billion in enterprise value…that’s an area where there’s less capital and competition.”

That transaction market for infrastructure assets has slowed somewhat since interest rate hikes began in 2022. However, Burnett notes that most major institutional players are continuing to scale up their infrastructure exposures and have picked up somewhat so far in 2024 from their lows at the second half of 2023.

The roughly $1 trillion (USD) transaction market is roughly 50 per cent in North America, with another 30 per cent of assets in developed Europe. Around 15 to 20 per cent of the market is assets in the rest of the world. North America and Western Europe, Burnett says, continue to dominate the transaction market despite some interest from select institutions in Asia.

Burnett sees the mid-market area as so attractive largely thanks to valuations. He sees small to mid-market assets as anywhere from three to four times cheaper on an multiple basis to what he sees in the large-cap space. He notes that this segment also tends to contain some of the more growth-oriented plays in the infrastructure market today. Those include data storage, telecoms, and renewable energy infrastructure. That growth orientation, and exposure to narrative mega-trends like the rise of AI, has allowed those assets to grow despite higher interest rates.

Despite their apparent solidity and stability, Burnett says that the larger-cap assets in infrastructure often tend to be the most interest rate sensitive. That’s because most of these assets are fully stabilized and have long-dated cashflow streams. That predictability makes them a strong core asset, but also leaves them vulnerable to short-term cost fluctuations due to factors like interest rate increases.

While the growth in AI-related assets like data, telecom, and renewable energy has been remarkable, Burnett notes that their valuations have risen somewhat above their normal levels. He sees some risk of overvaluation in these assets right now and notes that some contrasting assets could be more attractive. Those include traditional energy assets such as pipelines.

That doesn’t mean Burnett is writing off these AI exposed infrastructure assets. He sees the rise of AI — with its requisite demand for huge amounts of energy, computing, and data storage — as a fundamentally infrastructure enabled theme. However, he thinks investors need to take an asset specific approach to avoid some of the risks that may come with overvaluation or hype.

Burnett cites the example of a recent data centre deal. That business was listed at a 25x multiple, but the pipeline for new facilities was fully leased to an existing customer mix, the properties just needed to be built. There was a real predictability of growth thanks to customer demand. Despite the topline multiple looking expensive, the asset could justify its price. Burnett believes an approach like that can help investors succeed.

As asset managers look at infrastructure exposures and consider what they may be able to provide for their plans, Burnett continues to advocate for the small to mid-market assets.

“There are some really compelling assets there, compelling propositions for value creation,” says Burnett. “But remember that not all assets are created equal, regardless of the sector that they’re in. You can have high multiple assets with good visibility into future cashflow streams, and you can have high multiple assets with very poor visibility into future cashflow streams, and investors need to understand how to underwrite those risks in very similar sectors.”