The Case for Private Infrastructure in the Modern Era
Executive Summary:
- Investor interest and new private infrastructure investment strategies have helped the asset class grow market cap by nearly 320x in the last 24 years.
- The growing asset class has generated attractive historical performance with a 10-year Sharpe ratio of 1.58, along with unique return characteristics such as downside protection, low volatility, potential alpha and inflation protection.
- Private infrastructure’s positive historical performance and the current macroeconomic tailwinds signal that the modern era of this asset class is picking up steam.
Private Infrastructure: From Billions to Trillions
Private infrastructure has been the biggest growth story of the private markets over the last 24 years, growing from about $5B in 1999 to $1.3T (with a capital “T”) in 2023, reflecting a 26% CAGR. This growth trend kicked into full swing following the GFC as we entered the “modern era” of private infrastructure. The main growth catalyst came from investors who, reeling from equity losses, were looking for investment alternatives that offered downside protection with potential upside in a declining-rates environment. This dynamic spurred the search for yield, especially as the money supply ballooned and inflation risk concerns were renewed. As a result, we’ve seen infrastructure grow from a proof-of-concept to a mature industry in a relatively short amount of time.
Evolution of the Private Markets
Downside Protection Drives Private Infrastructure Growth
In light of investor desire and an increasingly attractive opportunity set, infrastructure began to move away from higher risk strategies (i.e., opportunistic) to those focused on assets with stronger contracted cash flow profiles. The emphasis was on developed markets and investors shied away from key headline risks, such as commodity prices, technology, government subsidies, greenfield development and merchant power pricing. This shift led to a new universe of strategies which were asset intensive and inherently more stable. These new infrastructure strategies were investor friendly, providing downside protection while retaining the business-plan optionality to drive upside returns, specifically within the core-plus and value-add spaces, where there was a particularly attractive intersection of risk and return. As the pendulum swung away from opportunistic strategies towards core, core-plus and value-add, we began to see downside protection become more pronounced. In fact, infrastructure broadly produced positive returns every single year from 2010 forward, even in the midst of the pandemic and throughout the onset of inflation and the rising rate environment that we’ve experienced since early 2022.
Real Assets Performance
Maximizing Total Returns for Private Infrastructure
Downside protection isn’t the only factor that attracts investors to private infrastructure, however. We’ve also observed attractive total returns through upside that is on par with public equity, with a fraction of the volatility. Private infrastructure has posted a 10-year Sharpe ratio of 1.58 (ending September 30, 2023), which doubles the risk-adjusted performance of all major asset classes. While the chart below focuses on total return, it is important to note that income makes up a meaningful portion of private infrastructure performance. This is because infrastructure assets are generally contracted and generate free cash flow that is utilized in a variety of ways to maximize investor value, including income distributions and funding accretive capital expenditures. Income is a significant driver of core strategy returns but typically gives way to appreciation as you move up the risk spectrum.
Risk-Adjusted Returns
10-Year Asset Class Risk-Adjusted Performance
Annualized Time-Weighted Returns as of September 30, 2023
Private Infrastructure’s Outperformance
While the beta story is favorable in private infrastructure, we continue to see value in manager selection with top-half strategies adding several hundred basis points of outperformance across vintage years. Like all things in the private markets, we see tremendous value in portfolio construction and careful manager selection. Alpha or not, the asset class has outperformed the public markets every single vintage year since 2012, as seen in the chart below.
Infrastructure IRR vs. PME
By Vintage Year
Downside protection, attractive total returns, low volatility and the potential for additional alpha – what more can you ask for? How about inflation protection as well, because, why not? While the results aren’t fully tabulated yet, early indicators suggest that private infrastructure is checking off many of the boxes on this wish list, especially as we navigate the modern era’s first prolonged period of elevated inflation. And even more so if we zoom in on Q1 2022 - Q3 2023, during which period U.S. CPI averaged 5.3% on an annualized basis.
Growth by Strategy (Indexed to $100)
By Vintage Year
The Modern Era of Private Infrastructure Is Just Beginning
In our experience, having deployed significant amounts of capital into the private infrastructure space for the last ~25 years, this asset class has lived up to expectations - and then some - and the case for investment continues to build. Many major macroeconomic tailwinds, such as the energy transition, digitization, supply chain and logistics, are pushing the asset class forward, and we expect the trend to continue as investors look to benefit from infrastructure’s attractive return characteristics.
We provide further insights and observations across real estate in our 2024 Real Assets Market Overview. Please complete the form below to receive an emailed copy of the report.
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As of June 5, 2024
Real assets consists of 40% real estate, 40% infrastructure, 20% natural resources.
Hamilton Lane data via Cobalt as of September 30, 2023, Bloomberg as of January 2024.
Hamilton Lane Data via Cobalt, Bloomberg. Indices used: Hamilton Lane All Private Equity with volatility de-smoothed; S&P 500 Index; Russell 3000 Index; MSCI World Index; HFRI Composite Index; Hamilton Lane Private Credit with volatility de-smoothed; Credit Suisse High Yield Index; Barclays Aggregate Bond Index; Hamilton Lane Private Real Estate with volatility de-smoothed; Hamilton Lane Private Infrastructure with volatility de-smoothed; Hamilton Lane Private Natural Resources with volatility de-smoothed; FTSE/NAREIT Equity REIT Index; DJ Brookfield Global Infrastructure Index; MSCI World Energy Sector Index. Geometric mean returns in USD. Assumes risk free rate of 2.3%, representing the average yield of the ten-year treasury over the last ten years. (January 2024)
Source: Hamilton Lane data, Bloomberg as of January 2024. Please refer to endnotes and definitions in appendix.
For illustrative purposes only. Actual results may vary.
Hamilton Lane Data, Bloomberg (January 2024).
All Private Markets – Hamilton Lane’s definition of “All Private Markets” includes all private commingled funds excluding fund-of-funds, and secondary fund-of-funds.
Corporate Finance/Buyout – Any PM fund that generally takes a control position by buying a company.
Credit – This strategy focuses on providing debt capital.
Growth Equity – Any PM fund that focuses on providing growth capital through an equity investment.
Infrastructure – An investment strategy that invests in physical systems involved in the distribution of people, goods, and resources.
Natural Resources – An investment strategy that invests in companies involved in the extraction, refinement, or distribution of natural resources.
Private Equity – A broad term used to describe any fund that offers equity capital to private companies.
Real Assets – Real Assets includes any PM fund with a strategy of Infrastructure, Natural Resources, or Real Estate.
Real Estate – Any closed-end fund that primarily invests in non-core real estate, excluding separate accounts and joint ventures.
Venture Capital – Venture Capital incudes any PM fund focused on financing startups, early-stage, late stage, and emerging companies or a combination of multiple investment stages of startups.
Index Definitions
Credit Suisse High Yield Index – The Credit Suisse High Yield index tracks the performance of U.S. sub-investment grade bonds.
DJ Brookfield Global Infrastructure Index – The DJ Brookfield Global Infrastructure Index is designed to measure the performance of companies globally that are operators of pure-play infrastructure assets.
MSCI World Energy Sector Index – The MSCI World Energy Sector Index measures the performance of securities classified in the GICS Energy sector.
MSCI World Index – The MSCI World Index tracks large and mid-cap equity performance in developed market countries.
Russell 3000 Index – The Russell 3000 Index is composed of 3000 large U.S. companies, as determined by market capitalization.
S&P 500 Index – The S&P 500 Index tracks 500 largest companies based on market capitalization of companies listed on NYSE or NASDAQ.
Other
Time-weighted Return – Time-weighted return is a measure of compound rate of growth in a portfolio.
PME (Public Market Equivalent) – Calculated by taking the fund cash flows and investing them in a relevant index. The fund cash flows are pooled such that capital calls are simulated as index share purchases and distributions as index share sales. Contributions are scaled by a factor such that the ending portfolio balance is equal to the private equity net asset value (equal ending exposures for both portfolios). This seeks to prevent shorting of the public market equivalent portfolio. Distributions are not scaled by this factor. The IRR is calculated based off of these adjusted cash flows.
Sharpe Ratio – The Sharpe Ratio is the average return earned in excess of the risk-free rate per unity of volatility or total risk.