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Hedging with Infrastructure / 2023 Outlook

By February 2, 2023June 15th, 2023No Comments

Over the past year, the global economic landscape has been characterised by a persistent state of high inflation, volatility, and deteriorating conditions. These trends are expected to continue unless there is intervention from central banks or resolution to ongoing geopolitical conflicts. In such an environment, it has been observed that infrastructure investments tend to exhibit greater resilience and better performance compared to equities.

Vytautas Plunksnis, the head of private equity at INVL, believes that this trend will persist in the coming year. He posits that during times of uncertainty and rising interest rates, investors tend to seek refuge in tangible assets such as infrastructure. The correlation between rising inflation and the inclination towards infrastructure assets by private equity firms is further highlighted by Mikael Karlsson, the CIO at Actis. He notes that sustainable infrastructure projects often feature revenue streams that are adjusted for inflation, thereby providing predictable cash flows and an attractive risk-adjusted return.

The €12.9 billion (about $13.8 billion) acquisition of Suez in January, led by Meridiam and Global Infrastructure Partners, was the year’s largest European infrastructure deal. In second place was the €9.3 billion purchase of Autostrade per l’Italia in March by Blackstone, Cassa Depositi e Prestiti and Macquarie Asset Management.

Historically, one of the reasons for infrastructure’s robust performance in inflationary periods is that infrastructure assets are typically characterised by long-term contracts and regulated pricing mechanisms that are linked to inflation. This means that as prices rise broadly across the economy, the revenue streams generated by these assets also increase, providing a hedge against inflation. Additionally, the essential nature of infrastructure projects means that they are less affected by economic downturns, providing a more stable source of returns for investors. There are several other known advantages for infrastructure investments, such as diversified earnings, a track record of consistent returns, the ability to upgrade portfolios, and compelling valuations at present.

The story of inflation is likely to continue throughout 2023. While both the European Central Bank (ECB) and the US Federal Reserve (Fed) have the tools to raise interest rates and combat inflation, it is more challenging for the ECB to do so. The ECB has a more complex policy environment with different economic conditions across its member states, which can make it harder to achieve consensus on monetary policy decisions. Additionally, the ECB has a more limited toolset compared to the Fed, and it is also prohibited from directly financing governments, which limits its ability to respond to economic downturns.

In sum, the current economic conditions and the trend of rising inflation make infrastructure investments an attractive proposition for private equity firms. Its ability to provide predictable cash flows and attractive returns, coupled with its critical role in meeting society’s needs and its historical performance in inflationary periods, make it a viable solution for investors looking to navigate the tumultuous economic landscape. Furthermore, the challenges faced by the ECB in raising interest rates and combating inflation make infrastructure investments even more appealing for investors based in the Eurozone.