Infrastructure Investment Funds

The current period is characterized by high uncertainty as investors try to assess how long central banks around the world will continue raising interest rates, and when rate cuts will begin — in response to the fight against inflation, which has moderated but remains elevated. Time will tell what the consequences of the ongoing conflict between Russia and Ukraine will be, and what the long-term effects on the global economy and financial markets will look like. For precisely these reasons and more, the Carlyle investment fund published an article explaining the attractiveness of infrastructure investment — as an asset class that effectively protects against inflation, has low correlation to the broader economy, and offers attractive returns in periods of uncertainty.

A Unique Opportunity Set Given the Macroeconomic Backdrop

Carlyle believes that investing in infrastructure provides a unique opportunity set given the current macroeconomic environment and the high expected returns compared to similar assets. The macroeconomic picture is expected to continue improving, supported by favorable fiscal policy in the form of stimulus programs approved by governments around the world, as well as additional spending related to net-zero transition policies and digitization processes that accelerated since the onset of the pandemic. Given the enormous investment sums that will be required over the coming years, private investment funds will play a significant role in modernizing the global infrastructure sector — facilitating the transition to a cleaner, more digital economy.

In addition to infrastructure investing carrying the lowest risk among alternative asset classes, it can also provide highly effective protection against rising inflation, given the inflation-linked, contractual nature of its cash flows. Furthermore, the long maturity of the assets, high cash yield, and inflation protection make infrastructure investment highly attractive — and a worthy potential alternative to investment-grade (IG) corporate bonds.

Infrastructure as a Defensive and Diversifying Investment

While many investors view alternative investments as a growing component of a portfolio, Carlyle believes that infrastructure investment offers significant advantages as a tool for managing long-term liabilities and as a defensive investment that provides diversification both in the asset class itself and in the overall risk profile of the full portfolio. From a broad market perspective, infrastructure has historically exhibited the lowest volatility and the lowest maximum drawdown risk among all asset classes.

Thanks to the yield-generating structure of infrastructure assets — particularly in the current environment — infrastructure investment can serve as an attractive potential substitute for corporate bond investment. This conclusion is supported by several facts. First, compared to investment-grade (IG) corporate bonds, infrastructure offers significantly higher cash yields, in fact comparable to those of B-rated bonds. Additionally, infrastructure investment provides an opportunity to invest in long-term assets with built-in inflation protection. These characteristics make it ideal for hedging long-term liabilities and protecting against the risk of higher inflation — which last year reached 40-year highs as a result of expansionary monetary policy combined with supply chain disruptions.

Investing in Real Assets with Bond-Like Risk

The risk profile of infrastructure investing is similar to that of short-duration investment-grade (IG) bonds. By comparing the historical default rates and returns of both asset classes, we can see that the calculated default rates for infrastructure investment are actually comparable to those of BBB-rated corporate bonds, while the returns are more than double. This further supports the use of this investment channel as a potential substitute for IG corporate bonds. Moreover, losses in infrastructure investment tend to be idiosyncratic rather than macroeconomic in nature. During the Global Financial Crisis (GFC), infrastructure projects did not experience a sharp rise in defaults, whereas such defaults did occur in the corporate credit sector. The clear and logical conclusion is that infrastructure investment is less risky than IG corporate bonds, and also provides portfolio diversification through its low correlation to the economy and markets (low beta).

A Positive Macro Backdrop

The macroeconomic picture for global infrastructure has improved significantly since the COVID crisis and the fiscal programs approved thereafter, following years of underinvestment by governments around the world. In many advanced economies, infrastructure investment fell by 10% to 30% as a share of GDP on average. As governments around the world announce more and more fiscal programs, they are relying on the private investment fund industry to play a significant role given the enormous investment that will be required in the coming years. The core opportunity in infrastructure investing lies both in maintaining existing infrastructure — which has been neglected over recent decades in large developed economies — and in upgrading it to meet new global trends.

U.S. infrastructure has suffered from years of neglect, and just recently (June 2023), a section of Interstate 95 in Philadelphia — one of the oldest and most important routes in the U.S. interstate highway system — collapsed following an accident that triggered a tanker fire. The collapse is expected to cause significant disruptions in the region, both in passenger traffic and in goods supply chains.

Another example is the accelerated digitization trend spurred by the pandemic: the rapid shift of millions of workers to remote work environments, the overnight surge in e-commerce sales, and the migration of other human and business interactions from physical to virtual spaces. A further example is investment in telecommunications infrastructure (data centers, fiber optics), which is essential for the continued growth of digital activity — including the rollout of 5G networks and other supporting services.

As many countries and companies around the world declare net-zero emissions targets by 2050 and energy markets shift toward renewable energy accordingly — this reality provides even greater investment opportunities. The transition to renewable energy — wind and solar in particular — is expected to be the fastest-growing energy source over the next 30 years, with reasonable scenarios projecting that renewables will account for between 22% and 44% of global energy supply by 2050 (Figure 12). Meeting these production targets will require enormous investment — between $330 billion and $534 billion per year according to the International Energy Agency — a large portion of which will need to come from private investment funds. While it is clear that future energy needs will be met by renewable sources, the transition to such an economy is expected to be gradual. To facilitate an efficient transition, significant investment is needed not only to make current energy production methods more efficient and environmentally friendly, but also to simultaneously meet the world’s growing demand for energy.

Conclusion

The risks to the economy from the ongoing Russia-Ukraine conflict, and the growing concern about high inflation and even stagflation, make infrastructure investment more relevant than ever. Combined with today’s macroeconomic picture of supportive fiscal policy and momentum toward a more sustainable economy, these factors provide significant tailwinds for this asset class. Furthermore, given the high cash yields of these assets, their low risk, and the inflation protection they offer, infrastructure investment is attractive and even less risky compared to other similar investment assets.

Disclaimer: The information in this article constitutes a general presentation of data and does not constitute a “public offering,” investment advice, or investment marketing, and is not a substitute for investment advice tailored to the individual’s data and needs. Past fund performance does not guarantee future results.