15 / 01 / 24 - 7 minute read
Despite initial fears of recession and volatility in 2023 due to high rates, inflation, and geopolitical tensions, global equity markets returned an incredible 20% for the year overall. Looking forward to 2024, investors are growing increasingly confident that cash rates and bond yields have seen their peak, with central banks having 'done enough' in terms of interest rate rises to control the rampant inflation that followed the COVID-19 pandemic years, leading to optimism for the year ahead.
A year ago, investors were concerned about high interest rates, hard-to-tame inflation, a mixed economic outlook and rising geopolitical tensions. A recession in the second half of 2023 was considered a possibility and volatility a certainty. In the end, global equity markets returned an incredible 20% for the year overall. That 2023 would finish as such a strong year was hard for investors to imagine at various points throughout the year, including in the midst of a US regional banking crisis following the collapse of Silicon Valley Bank, and the coincidental fall of Credit Suisse in Europe. Global bond markets continued to be volatile but even they finished the year up 4.7%.
Looking forward to 2024, investors are growing increasingly confident that cash rates and bond yields have seen their peak, with central banks having ‘done enough’ in terms of interest rate rises to control the rampant inflation that followed the COVID-19 pandemic years. Headline measures of inflation for the major developed markets are well below their 2022 peaks, but core measures of inflation (which exclude volatile food and energy prices) are declining more slowly than the headline measures and remain well above where central banks would like them to be. As we start 2024, markets are mostly expecting central banks will be able to successfully engineer a ‘soft landing’ scenario, but we remain mindful that achieving such an outcome has previously proven challenging.
A complex geopolitical landscape looks set to continue in 2024 and beyond, with the conflict in Ukraine evolving into a war of attrition and the dramatic onset and subsequent escalation of conflict between Israel and Hamas in the last few months of the year. The fracturing of the geopolitical landscape will likely lead to heightened trade tensions, the further desynchronisation of global supply chains, ‘friend-shoring’ and greater emphasis on energy and resource security.
These themes shape the investment outlook for 2024, with our view being that the global economy will experience stagnating economic growth and that the risk of mild recessions in developed markets over the next year remains elevated.
How should investors navigate these evolving conditions? We consider infrastructure remains well-placed to navigate the near-term challenges and uncertainties, especially given its relative ability to protect against both surges in inflation and slower economic growth. Additionally, the longer-term secular trends such as the energy transition and digitalisation will shape investment opportunities in 2024 and beyond. The complexity of the outlook should play to the strengths of astute active managers in infrastructure that are able to navigate the opportunities and risks in their preferred market segments.
 Per the MSCI World Index in euros.
 Per the Bloomberg Barclay Global Aggregate Index, hedged to euros.
The high inflation and rising interest rates that characterised 2023 marked one of infrastructure’s first real tests in its relatively short lifespan as an institutional asset class. While performance remained resilient, fundraising plummeted to levels not seen since 2017 and infrastructure deal activity was significantly below that achieved in recent years.
Rising interest rates were certainly among the key headwinds for infrastructure fundraising in 2023, and according to a recent survey of investors conducted by Preqin, investors continue to be concerned about the impact that higher rates will have on return generation in the asset class over the next year. However, with some anticipated moderation in cash rates and bond yields in 2024, investors are likely once again find relative attraction in the stable yield and strong long-term returns offered by the asset class. This is particularly the case given the infrastructure asset class remains under-owned by institutional investors in some geographies and by private wealth investors.
Investor Outlook – Key Challenges in the Next 12 Months
Source: Preqin, December 2023
Infrastructure deal activity, while more resilient than in real estate, fell across all geographies in 2023, as both buyers and sellers expressed caution about the macroeconomic outlook and the impact of a ‘higher-for-longer’ interest rate environment. Even though infrastructure managers have accumulated over US $300 billion in dry powder on the back of exceptionally strong fundraising in 2021 and 2022, in the large-cap end of the market deal, activity was more muted as buyers and sellers adjusted to a higher-rate environment. In the mid-market, deal activity remained strong in 2023 and we are optimistic that deal activity will continue to gather pace in 2024 as market expectations of inflation and the interest rate environment adjust.
While fundraising and deal activity were challenged in 2023, performance of the asset class remained strong. Infrastructure’s generally resilient returns amid a period of embedded inflation and higher interest rates, following two decades of benign inflation prior to the pandemic, has served as an important reminder of the broad inflation hedging and diversification attributes of the infrastructure asset class.
As we start 2024, it is clear that investors continue to value infrastructure for its ability to provide inflation hedging, more so than any other alternative asset class, alongside its diversification, income and correlation benefits.
Investor Rationale for Investing in Alternative Asset Classes
Source: Preqin, December 2023
While it was undeniably a tough year for infrastructure fundraising, green shoots started to emerge midway through 2023. Few funds reached a final close in 2023, however, capital raised in interim closes in Q2 was in line with the long-term historical average and this was above average in Q3. Our take on this is that infrastructure funds have been successfully raising capital but have not yet called final closes, likely because they do not want to miss out when investor interest in the asset class recovers.
In the face of another year of uncertainty, infrastructure investors will do well to look across the capital structure for investment opportunities. According to a survey of infrastructure fund managers conducted by Preqin in November 2023, over a third of managers are considering launching infrastructure debt funds. Investor sentiment towards infrastructure debt has also been improving, as rising base rates and spreads have increased the attractiveness of debt relative to some low-risk core infrastructure equity strategies. However, history shows that the window to invest in infrastructure debt at all-in returns that are similar to, and sometimes higher than, lower risk (‘super core’) infrastructure equity does not persist over the long term, and there is therefore a limited time for investors to participate in the current compelling return opportunity.
The longer-term outlook remains strong
Infrastructure’s investment horizon remains long-term in nature, and secular trends will continue to shape opportunities in 2024 and beyond. These long-term secular trends will underpin infrastructure investment returns in the years ahead.
Decarbonisation and the energy transition will undoubtedly provide strong tailwinds to the infrastructure asset class given how much investment is needed each year to achieve decarbonisation objectives. Private investment in renewable energy assets has been surging in recent years and half of all deal activity in 2023 was in the renewables sector. One of the key challenges of the transition to renewable energy is the inability of solar and wind power to provide steady, constant energy around the clock and regardless of weather. It is against this backdrop that the drive for a broader range of renewable energy assets and also grid-scale energy storage have gathered considerable momentum. Once the preserve of pumped hydropower stations, new forms of energy storage are emerging as solutions. Each carries its own benefits and drawbacks, and not all are likely to gain traction over time. Nonetheless, the nascency of the sector makes it an exciting time, and likely to be a key source of investment opportunities in the years to come.
The pace of digitalisation continues to accelerate; in this increasingly digital world, internet speeds, reliability and broadband coverage need to increase, and data storage needs to be ramped up, making significant investment in physical digital infrastructure critical. Investment opportunities for private investors exist across the sector, however, we consider reliable high-speed fibre networks and data centres to be particularly attractive asset types within the asset class given their role in facilitating the growing reams of data created around the globe and the growing investment opportunities available.
Opportunities for investment in the mid-market remain abundant, underpinned by the relatively smaller deal sizes for sectors such as social infrastructure, some renewables segments (energy-from-waste, district heating and distributed solar) and ‘smart cities’ digital infrastructure. Furthermore, we anticipate elevated geopolitical risks could serve as a catalyst for the decentralisation of infrastructure, leading to a larger number of smaller infrastructure projects.
Undoubtedly, 2024 will prove to be another interesting year, but it is ultimately the long-term megatrends that will drive long-term investment returns. Infrastructure’s pivotal role in generating environmental and societal outcomes over periods measured in decades rather than years, offers cause for optimism.
Graham Matthews is CEO Infrastructure at PATRIZIA. He was formerly the founding shareholder and Chief Executive of Whitehelm Capital before the business merged with PATRIZIA in 2022.
Graham joined the Whitehelm team in 1998 and started the firm’s infrastructure business at the time when private ownership of public infrastructure originated globally. Graham previously held senior roles in the Australian Federal Treasury and represented Australia at the International Monetary Fund in Washington DC.