19 / 07 / 23 - 4 minute read
In 2022, inflation surged to multi-decade highs amid supply chain disruptions, overly accommodative policy settings and the outbreak of war in Ukraine. Since then, central banks have had to play catch-up in their fight to rein in inflation, by aggressively hiking interest rates over the course of the past 18 months.
Headline inflation levels are forecast to gradually moderate over the medium term, as economic growth slows in response to the tighter financial conditions. However, core inflation measures, which exclude the prices of volatile energy and food items, are retreating more slowly than markets expected at the outset of 2023, and inflation remains a key investment risk.
The higher interest rate environment has affected many asset classes, and infrastructure has not gone unscathed. In this mid-year review, we provide an update on the landscape of the infrastructure market.
Fundraising across both infrastructure equity and debt was sluggish in the first half of 2023
After a record-breaking year in 2022, fundraising plummeted in the first half of 2023. The first quarter of the year marked the worst quarter of infrastructure fundraising since 2009, with just US$8 billion raised, in comparison to US$23 billion in the first quarter of 2022. One driver of the sluggish fundraising has been the slowdown in exits and the accompanying delay in returning money to investors. This has a knock-on effect as investors often cannot commit to new funds given the uncertainty of the timing of returning capital from harvesting funds. Infrastructure debt fundraising has been similarly challenged – capital raising in 2023 has experienced a material fall, and there has been a virtual freeze on funds closing this year.
Importantly, this downturn in capital raising is not unique to the infrastructure asset class. Private real estate recorded its lowest quarter in Q1 2023 since 2009, private debt its lowest in six years, and private equity fundraising is down 20% year-on-year.
Unlisted Infrastructure – Capital Raised and Number of Funds Closed, 2014 – 2023
Source: PATRIZIA, Preqin Pro
Deal activity is also materially lower year-to-date
Deal activity has bucked its decade-long trend of increasing year-on-year, with the number of deals and cumulative value of deals expected to be materially lower in 2023, to be in line with levels last seen in 2018. Renewable energy continues to be the dominant sector for deal activity, making up nearly half of all infrastructure deals so far in 2023. Within the renewables sector, greenfield deals have been more attractive to investors, not only because of the higher returns on offer given the development risk premium, but also because greenfield assets can offer strong alignment with the climate change thematic and can help with improving energy security. Europe continues to lead the way for deal activity, making up 50% of all completed transactions year-to-date, reflecting the significant momentum behind improving energy security; 25% of the remaining deals were transacted in North America.
Infrastructure Equity Deals by Volume and Value. 2013 – 2023
Note: 2023 year-to-date deals extrapolated by the last three-year average of the number of deals to May, versus the full year deal count.
Source: PATRIZIA, Preqin Pro.
Dry powder has decreased from end-2022 highs, but remains elevated
Following record levels of fundraising in 2021 and 2022, a record level of dry powder was accumulated by infrastructure fund managers at end-2022, especially those with a large cap and North American focus. Dry powder was at record levels at the end of 2022, but with the decline in fundraising to start 2023, dry powder stocks have reduced by US$17 billion to just over US$300 billion to start the year. However, dry powder remains elevated as funds that have previously raised capital search for opportunities to deploy.
Unlisted Infrastructure Dry Powder by Strategy, 2014 - 2023
Source: PATRIZIA, Preqin Pro
The investment outlook for the second half of 2023 is no doubt challenging, with higher interest rates the most pressing concern
As the global economy goes through a bout of significant uncertainty, investors will have to navigate deftly a range of headwinds. While the key challenges faced by infrastructure investors in recent years – such as valuations, competition for assets and geopolitics – remain a concern, the impact of rising interest rates is now paramount. As with other asset classes, higher rates can impact asset valuations, refinancing costs and broadly curb economic activity.
Sentiment has softened across all real asset classes as a result of the higher interest rate environment. However institutional investors expect the infrastructure asset class to perform better in the short to medium term than both real estate and private equity, reflecting the fact that infrastructure can offer relatively higher inflation protection and lower GDP linkage than other real asset classes.
As a result, when looking at the expected capital commitments of institutional investors, infrastructure commitments are expected to grow over the next 12 months versus the last 12 months. Investors are prioritising existing relationships through pursuing ‘re-ups’, that is, allocating to follow-up funds with existing managers rather than appointing new managers.
Investors Expected Capital Commitments – Next 12 Months vs. Last 12 Months
Source: PATRIZIA, Preqin Pro
Despite this softened sentiment from institutional investors, family offices are providing a beacon of light to infrastructure fund managers, with family offices reported to intend to increase their allocations to infrastructure more so than any other real asset class in 2023, with investors citing the inflation protection and diversification benefits as the primary rationales.
 BlackRock Global Family Office Survey, January 2023