Infrastructure is all around us. It’s economic infrastructure, like roads, bridges and airports. It’s social infrastructure such as hospitals and schools. It’s digital infrastructure in the form of communications towers, data centres and networks. And it’s environmental infrastructure, such as offshore wind farms and solar.

Whatever the type of infrastructure, it’s critical to the functioning of modern society - so should it also be a critical component of your investment portfolio?

Infrastructure, as an asset class, has several attractive attributes for investors.

The first I will highlight is that because infrastructure assets are linked to essential services underpinning the economy and the everyday functioning of society, demand is relatively stable, and the asset values are less volatile than traditional equities. Because people will pay for services like water, electricity and even mobile phone data throughout the economic cycle, revenues of infrastructure assets are far more resilient in an economic downturn, and therefore cashflows are more predictable and reliable.

A study of changes in the cash flows of unlisted American and European infrastructure assets belonging to six different subsectors during 1986-2010, backs this up - the cash flows of these assets demonstrated relatively low volatility over time. Moreover, the study found a very low correlation between the cash flows of infrastructure assets and similar indicators for equities and real estate*.

What’s more, many infrastructure assets are also regulated or have contracts linked to inflation, and therefore can add a level of valuable inflation protection to a client portfolio. With a substantial proportion of assets also backed by the public sector and/or having very long-term contracts, there is additional counterparty security to the income streams the assets generate versus your typical corporate loan/bond.

With long dated assets and a built-in resilience to the economic cycle, coupled with significant inflation hedging, the asset class displays exceptionally low correlation with the broader market, bringing an important source of diversification to any investment portfolio.

To illustrate infrastructure’s diversification potential, another study also took an example portfolio of 55% equity, 35% bonds and 10% real estate, looking at hypothetical annual returns under various scenarios when adding infrastructure assets to the mix (5%-20% of the overall portfolio). It showed that while portfolio total returns improved moderately, there was significant reduction in volatility**.

Infrastructure assets tend to be capital intensive to build and maintain. This is where infrastructure debt investors step in – lending the money to build and/or operate the facilities.

While not as exciting, and not promising as high returns on capital, debt has a number of benefits over equity investments. For starters, it has clearly defined returns: you loan an agreed amount of money for an agreed time period at an agreed rate of interest.

Infrastructure debt also has the advantage of having lower default rates compared with rated corporate debt***. Studies show that, by year 10 of investment, there is on average just a 1.2% default rate across the asset class vs 14.1% across non-financial corporate debt***. This is further evidenced by Gravis’s annualised loss ratio of just 0.41%, which is significantly lower than the 2.11% of unsecured high yield bonds offering a similar level of return to that Gravis has achieved****.

And even when things go wrong, infrastructure debt recovery rates are relatively high: 76.9% according to Moody’s***. In most cases (62%) the ultimate recovery rate is 100% - i.e. no capital loss***.

The infrastructure investment sector has grown exponentially in the past 10-15 years, with assets under management rising from $161bn in 2010 to $1.1trn at the end of 2022*****. This growth is predicted to continue with assets likely to reach $1.7trn by the end of 2028*****.

This growth is being driven by three major, long-term trends: digitalisation, decarbonisation and deglobalisation and the UK is playing a big part in this.

1) Digitalisation

The so-called ‘Fourth Industrial Revolution,’ in which digital technologies have changed the way we work, live and play, is well underway. As the technology available to us grows, so too does the demand for the data. In fact, the digital infrastructure needed to support and enable the storage and transmission of reams of data across the world every day – the data centres, communication towers, networks, and logistic centres – is now as critical as our transport networks.

2) Decarbonisation

According to Bloomberg NEF, $194trn of investment is required if the world is to reach net zero by 2050 ******. In the UK alone, £50bn investment per annum will be needed to reach our net zero targets – a five-fold increase on how much is invested today. In the next five years, the UK needs to produce almost three times the current level of renewable energy. In the next 25 years it needs to move from 215,000 heat pumps installed today, to 28m and the 1m electric vehicles currently on our roads need to become 37m. The list goes on. Governments won’t be able to fund this alone, so the private sector will play a huge role in this expansion.

3) Deglobalisation

The Covid-19 pandemic and Russia’s invasion of Ukraine accelerated a trend that had already begun: deglobalisation. Both events highlighted how relying on too-few suppliers and those located a long way from the point of sale, could result in shortages of supply. Countries around the world have reacted to this by shortening supply chains and bringing production closer to home either through reshoring or near-shoring. As they have done so, so demand for new transport, power and logistic centres has grown rapidly to support these changes.

My final point is that, while rising interest rates have put the infrastructure asset class valuations under pressure, and more expensive debt has led to less construction & fewer transactions, now could be a pragmatic time to revisit the sector. The higher yields on offer today could be locked in before interest rates fall further.

The big share price discounts to net asset value that many listed infrastructure investment companies find themselves on today, has been overdone in my view. As recent disposals by both GCP Infrastructure Investments and other investment companies have proven, the underlying asset values have been stable. This suggests there is a considerable opportunity for patient investors at current share prices – they are, in effect, being paid high single or double-digit income, while they wait for sentiment to close the unwarranted valuation gap.

*Source: “Infrastructure investing - A portfolio diversifier with stable cash yields,”, J.P. Morgan Asset Management, 2008.

The cash flows for listed equity are represented by the aggregated EBITDA (earnings before interest, taxes, depreciation, and amortisation – a measure of profitability to net income) of the companies listed on the NYSE. The real estate cash flows are represented by profits net of operating expenses aggregated by the NCREIF (National Council of Real Estate Investment Fiduciaries).

**Source: A guide to infrastructure investing, Af2i working group in partnership with J.P. Morgan Asset Management.

***Source: Moody’s investor services Infrastructure Default and Recovery Rates 1983-2021, 31 Oct 22

****Source: Moody’s Average loss rate for unsecured bond and Speculative grade for 2011-2023 and Gravis, calculated as IRR on infrastructure loans exited across GCP Infrastructure Investments and GCP Asset Backed Income Ltd as of 30 June 2024 .

*****Source: Prequin Insights Dec 2023.

******Source: BloombergNEF New Energy Outlook 2022.

Important information 

This article is issued by Gravis Capital Management Limited (“GCM”), which is authorised and regulated by the Financial Conduct Authority under Firm Reference Number 770680. GCM’s registered office address is 24 Savile Row, London, United Kingdom, W1S 2ES.

GCP Infrastructure Investments Ltd (“GCP Infra” or the “Company”) is a Jersey-incorporated, closed-end investment company. Its shares are traded on the main market of the London Stock Exchange. It is regulated as a certified fund in Jersey, pursuant to the Collective Investment Funds (Jersey) Law 1988. GCM is the Company’s Alternative Investment Fund Manager.

Any decision to invest in GCP Infra must be based solely on the information contained in the Prospectus, the latest Key Investor Information Document and the latest annual or interim report and financial statements.

GCM does not offer investment advice and this article should not be considered a recommendation, invitation or inducement to invest in GCP Infra. Prospective investors are recommended to seek professional advice before making a decision to invest. The merits and suitability of any investment action in relation to securities should be considered carefully and involve, among other things, an assessment of the legal, tax, accounting, regulatory, financial, credit and other related aspects of such securities. 

Your capital is at risk and you may not get back the full amount invested. Past performance is not a reliable indicator of future results. Prospective investors should consider the risks connected to an investment in GCP Infra, which include (but are not limited to), concentration risk, counterparty risk, inflation and interest rate risks and risks relating to property development and social infrastructure assets. Please see the detailed Risk Factors section in the Prospectus for further information.

This article has been prepared by GCM using all reasonable skill, care and diligence. It contains information and analysis that is believed to be accurate at the time of publication but is subject to change without notice. It is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. Any recipients outside the UK should inform themselves of and observe any applicable legal or regulatory requirements in their jurisdiction.