Infrastructure: a building block for growth

The value of investments and the income from them can go down as well as up and an investor may get back less than the amount invested.

Over recent years, infrastructure investment has become increasingly important for governments and investors alike. In developed economies, decades of underinvestment have left infrastructure networks and public services desperately requiring modernisation, while developing economies continue to invest in infrastructure projects to drive further growth. At the same time, governments recognise the need to adapt to structural themes that will shape their economies and societies for decades.

Investor demand for infrastructure assets has also grown significantly thanks to long-term trends affecting both institutions and individuals. Notably, aging demographics have extended the liability-matching and cashflow needs of defined benefit pension schemes and insurers. Meanwhile, a shift in responsibility towards individuals to save for their retirements means that defined contribution pension schemes and private investors are seeking more stable, long-term returns.

Infrastructure investments offer characteristics that appeal to each investor type – predictable cashflows, which may be secured against the underlying assets; low net asset value (NAV) volatility; inflation-linked protection, which may be contractual; and attractive total returns compared to public stock or debt markets. This is because investors can demand additional yields for tying up their capital over longer periods, which is known as the ‘illiquidity premium’. 

The sector is also continually innovating by providing broader access to infrastructure through new investment vehicles. New types of investment product, such as long-term asset funds (LTAFs) and European long-term investment funds (ELTIFs), offer better liquidity than traditional private asset funds. In other words, the end client’s investment can be converted into cash without the fund manager immediately selling underlying infrastructure assets while protecting existing investors. 

Structural themes driving future investment

We believe there are three key structural themes driving long-term infrastructure investment: the ongoing energy transition, demographic changes and urbanisation. The corresponding solutions to each offer a wide range of investment opportunities, which enable investor to construct infrastructure portfolios with meaningful diversification.

Energy

Energy-related investments can include both renewable energy projects and upgrades to traditional power generation and distribution networks, which are essential to improve energy efficiency and energy security. abrdn’s energy infrastructure investments range from funding the construction of new hydropower plants in Norway to upgrading biomethane facilities across Italy, which reduces the country’s reliance on imported gas, and investing in liquid energy bulk storage in South-East England to ensure the security of supply to critical infrastructure, such as airports.

Demographics and urbanisation

Societies are fundamentally changing as average ages increase across both Eastern and Western economies, while simultaneously shifting away from rural areas to urban centres. We also continue to dive deeper into digital worlds, with AI poised to revolutionise not only the technology sector, but also any industry that can utilise its potential, from finance to pharmaceuticals.

Infrastructure investment is essential to adapt to these structural trends. To support growing urban populations, transport networks must be upgraded and expanded. abrdn has funded the introduction of new, state-of-the-art trains that comprise 10% of all UK railway passenger rolling stock and is engaged in similar projects across Europe. Meanwhile, to drive digitalisation, we are building broadband fibre infrastructure in several rural regions in the UK, which will help to balance economic prospects between rural and urban areas.

Core infrastructure and concessions

Two key subsectors of infrastructure investment are core infrastructure and concessions. Core refers to assets that are essential to society, cannot be easily replaced and face little-to-no market competition. These include roads, railways, energy-related infrastructure, utilities and some digital assets. Inelasticity of demand underpins these assets’ investment characteristics, including their ability to provide stable, often inflation-linked cashflows. Investments typically involve an 8- to 10-year investment horizon with returns delivered through a combination of yield and capital appreciation.

Concessions, which include both core and non-core infrastructure, refer to public-private partnerships through which a public authority engages with private companies to design, build, finance and operate public assets. This provides significantly more capital to fund public infrastructure projects than would be available through state or local authority budgets alone, while bringing private sector expertise and alignment of interest. Investment horizons can be anywhere from 10 to 25 years or longer and total returns can be driven by income or through capital gains if the asset is exited post construction.

Allocating to infrastructure investments

Infrastructure’s role in an investment portfolio – and indeed how it can be access by investors – depends heavily on the client type. Again, this is because infrastructure projects require sizeable, long-term capital commitments, whereas investors can have vastly different liquidity and risk-reward requirements.

Local government pension schemes are among the biggest infrastructure investors as they remain open to new member contributions, which means they do not face the same liquidity constraints as other investor types and so can fully benefit from the illiquidity premium. 

Other investment vehicles exist for clients with greater liquidity needs. Among the most common structures are investment trusts, which are closed-ended funds with shares listed on a public stock exchange. Investors can buy or sell their stake in the trust on the secondary market as they would any other publicly listed company. Because no money flows into or out of the trust itself during this process, the underlying infrastructure assets remain unaffected.

Long-term asset funds (LTAFs) and European long-term investment funds (ELTIFs) are more recent innovations aimed at defined contribution pension schemes and, in some cases, individual investors. They have mutual fund structures but require investors to provide a minimum notice period to exit their investment. This protects existing investors because it gives the fund manager more time to sell underlying assets to raise cash in the event of large redemptions.

Investors can also gain infrastructure exposure indirectly through listed infrastructure funds, which buy shares in infrastructure-related companies. It is also possible to buy shares in publicly listed private equity companies, which earn profits from infrastructure investments. In the future, tokenised funds may increasingly open up infrastructure to new institutional and retail investors using blockchain technology.

Investor demand set to grow further

Neither the supply of infrastructure deals nor investor appetite for them appears to be waning. Global infrastructure assets under management will grow at over 7% per year to 2028, according to Preqin, while 54% of institutional investors planning to increase their portfolio allocations this year, according to Mercer. With ongoing innovation in this space to allow more investors to access the asset class’s potential benefits and government pressure to deliver on infrastructure objectives, we can see infrastructure playing a much more important role in investment portfolios over the coming years.