Infrastructure is an important component of many alternative investment portfolios. As real, capital-intensive, long-lived assets that provide essential public services, infrastructure investments can offer stable cash flows, inflation hedging, and low correlations to other asset classes. However, infrastructure also carries regulatory and construction risks. Investors utilize various approaches, including direct investing, fund investing, and public-private partnerships. Key considerations include deal structure, government involvement, project stage, and asset diversification across sectors like transportation, energy, utilities, and social infrastructure. When appropriately structured and diversified, infrastructure in alternative investments can provide steady yields and portfolio diversification benefits.
Infrastructure’s stable cash flows appeal in alternatives
Infrastructure assets like roads, airports, railroads, pipelines, and utilities often have monopolistic characteristics and provide essential services, leading to stable, predictable usage and cash flows over long periods. This makes infrastructure attractive to alternative investors like pension funds and insurers seeking steady income. Infrastructure’s long asset lives and high barriers to entry also give some inflation protection. Investors must account for demand uncertainty and regulatory risk, but the long-term contracted and regulated nature of many infrastructure revenues can complement the higher risk/return profiles of private equity, venture capital, and hedge funds in alternative portfolios.
Diversification benefits of infrastructure
The stable yield and inflation hedging characteristics give infrastructure low correlations to other major asset classes like stocks and bonds. Adding infrastructure to an alternatives portfolio can reduce volatility and enhance diversification. During period of equity market distress, infrastructure’s correlations to stocks tend to increase, so it is still somewhat linked to broad economic conditions. But diversified infrastructure exposures should provide some downside protection in most environments. Blending infrastructure with higher risk/return alternative strategies improves the risk-adjusted return profile.
Challenges of infrastructure investing
While infrastructure offers many benefits, there are also challenges investors must navigate. Construction and development risks can be substantial, especially for large greenfield projects. Demand forecasts may prove overly optimistic. Government and regulators play a major role, so political considerations and policy changes can impair project economics. It is difficult for smaller investors to access infrastructure deals, so most participate through funds or partnerships. Lack of liquidity in infrastructure investments means capital is locked up for years. Extensive due diligence is required across legal, financial, operational, and engineering issues to properly evaluate infrastructure deals.
Structuring infrastructure allocations
Infrastructure investments can be structured in various ways. Investors can buy publicly traded stocks and bonds of infrastructure companies. Government privatization schemes allow private capital to own infrastructure assets like airports and ports. Real asset funds focused on infrastructure are popular. Certain platforms allow co-investing alongside infrastructure funds. Direct investing provides more control but requires considerable expertise. Many private equity, real estate, and multi-asset managers now run infrastructure-focused funds. Allocations are tailored by project stage, geography, asset type, and risk level. Blending core, stable infrastructure like power plants with higher returning development projects is an effective approach.
Infrastructure is an attractive component of alternative investment portfolios, providing stable cash flows and diversification. But the asset class also carries unique risks that must be carefully evaluated. Appropriate structuring and diversification are key to realizing the return and risk management potential of infrastructure within the context of broader alternative investments.