Key Infrastructure Themes for the Year Ahead

2024 has seen a flurry of infrastructure investment activity. From allocating capital to megatrends like digitization to more essential infrastructure projects that focus on water and waste management, investors have shown an increased appetite for the asset class. We expect this trend to continue and would point to a few key themes which we believe make private infrastructure well-positioned for long-term success.  

Trends, challenges and opportunities 

While there are a number of megatrends shaping private infrastructure, it is important to point out that infrastructure opportunities vary by asset, region and market segment. We look to North American and Western European assets in the middle market where deal dynamics are especially crucial.  

In the small-to-middle market, infrastructure remains an asset-by-asset business, despite megatrends like digitization. There could be two assets following the same macro theme in the same sector, but the underlying deal quality may vary greatly. As a result, middle-market asset selection is key given the impact on portfolio performance. And that's where we shine. 

At the large end, we see opportunities across the energy transition, digitization and supply chain trends, but not as much in the environmental space. Environmental deals tend to be more fragmented and where a lot of the small cap opportunities live, which makes them harder for large and mega managers to access. 

In addition to asset selection, another challenge for infrastructure investors is accessing the small-to-middle-market space because there are so many opportunities to sift through. Investors must have both the bandwidth and the expertise to successfully underwrite small-to-middle market infrastructure transactions. Given the variability of deal quality, this is where the wheat is separated from the chaff. Having the right data and background to thoroughly diligence small-to-middle-market deals can turn challenges into opportunities in a market segment that's traditionally difficult to access. 

Our definition of the small end of the market is about $100 million to $2.5 billion in enterprise value. The overall opportunity set in the small-to-middle-market space is quite large and that's why we're focused on it – there are more value creation and exit opportunities as well as more attractive entry valuations.  

Looking at 2023 transaction flows, ~5% of the infrastructure market by number was in deals with enterprise values over $2.5 billion, and these deals comprised approximately half of the money transacted. This market share has been relatively consistent over prior years. So, while more money has been raised by larger funds, they continue to address a finite opportunity set on the ‘buy’ and a narrower band of exit opportunities on the ‘sell.’    

Secondary and co-investment transactions 

There is no single statistic out there that tells us the precise volume of infrastructure co-investments, but a good metric comes from our own pipeline. In 2023, we saw nearly $10 billion in co-investment deal flow. Going back further, we saw infrastructure co-investment transactions increase by more than five times over the last four years. That's an enormous increase in a relatively short period of time.  

The infrastructure secondary market has seen approximately $18 billion in volume YTD. While infrastructure secondaries are behind private equity secondaries by several years, the overall market has matured, and the secondary market is on track to reach approximately $30 billion in the next couple of years.  

From a secondary perspective, we prioritize fully funded positions because we want to see near-term realizations and have visibility into fund performance. We also want to invest at an inflection point where the blind pool has been unblinded, but also where we are buying into an interest that has not yet been substantially marked up. Acquiring positions at a discount can provide an immediate uplift in performance but buying in when value creation initiatives are taking hold can provide for both nearer-term distributions and long-term appreciation.  

On the co-investment side, we prefer deals that are underwritten for a 5-7-year hold period. Infrastructure co-investments tend to start generating income in year three, which can provide yield as a component of total return. But the total return profile on co-investments is generally a little higher than secondary investments when viewed from a multiple standpoint.  

When infrastructure co-investments and secondaries are combined in a portfolio, investors can potentially achieve near-term realizations and a strong longer-term multiple. In other words, investors are positioned to capture the best of both worlds depending on how the portfolio is constructed. We believe this approach has the potential to continue generating favorable, well-rounded returns into 2025 and beyond. 

Attractive areas for infrastructure investors 

We invest predominantly in North America and Western Europe, focusing on megatrends that make the most of each region's sector preferences and investment needs.  

We try to find good opportunities which are sustainable and offer the best risk-return profile. Take data centers, for example. Energy input and energy security are key components for any data center. In our case, we focus on long-dated contracted energy input derived from renewable sources. Cooling and water shortages must be addressed, too. To do this, we look for data centers that are in regions which consume less water or have natural cooling options available.  

2025 and beyond 

In the next 5-10 years, we expect the infrastructure market to at least double in size. Also, we believe the infrastructure secondary market - a core investment focus for Hamilton Lane - will continue to grow and will play a more prominent role within infrastructure portfolio construction. 

Looking ahead, we will see a different manager landscape than we have today. As groups grow or get acquired, and teams inevitably spin out to form new managers, we suspect there will be a deeper manager landscape and more specialist firms across the industry.