Alternatives, Asset Allocation, Asset Managers, ESG/SRI, Institutional Investors, Pension Funds, Private Equity, Public Funds

Renewables Dominate Infra Sector as ESG Resonates with Investors

Renewable energy deals heated up the infrastructure sector last year, as investors sought to put an Environmental, Social Governance (ESG) focus on more of their investment portfolios. The trend should continue this year, according to Patrick Adefuye, head of real assets at research firm Preqin. Europe has been leading the charge in renewable deal offerings, but the U.S. appears to be fast on the Continent’s heals regarding developing more renewable infrastructure projects going forward.

“The drive toward clean energy is a big factor [in infrastructure], in Europe, which is a leader on that front,” Adefuye said. “But it has also become increasingly important in the U.S., which is catching up to some degree. There is a lot of interest in renewable energy and going forward you would expect that to continue to be the case,” he said. 

Patrick Adefuye, Head of Real Assets Products, Preqin

An ESG Lens

Overall, the industry has seen a move away from high-carbon energy sources to low-carbon renewable energy sources, Adefuye noted. Within the sector, core deals are more popular than value-add or opportunistic vehicles, due to the higher amount of risk involved. “In the renewable energy space, if you are looking to build a new wind farm from scratch, that would be a risky investment, because you have to construct the wind farm, which takes a lot of time and cost, versus with core projects that already exist, and where the asset is already generating return and capital,” he explained.  

But for investors that are looking for higher returns, the value-add and opportunity vehicles may be the place to put their bets. Investors take on construction risk with these projects, “so if you get in early you can get potential returns, and they can pay off in a greater way than if you invested in an existing asset that is already generating steady returns,” Adefuye said. “It’s a big decision that investors have to weigh up: Do we want to take greater risk with investments that might not come to fruition at all, or do we want to stick to an asset that could be expensive to access and returns would be not as great as if you build it from scratch, but we know what the guaranteed returns will be,” he said.

From a portfolio perspective, “renewable energy is attractive because it meets some of the ESG goals that some investors have, and the fact that there are more investors setting ESG goals means the prospects for renewable energy are positive going forward,” Adefuye said.

Higher risk, higher returns in Asia

Preqin’s latest infrastructure report, 2019 Preqin Global Infrastructure Report, also showed that there has been a push by infrastructure investors to find higher returns, as the overall infrastructure landscape has become more competitive and returns are being compressed. Many investors are training  their sights on Asia.  “There is an element of necessity,” Adefuye said. “If you want higher returns, then you may have to seek it out in Asia. The Asian infrastructure market is growing, and renewable energy is important in that region, so that is creating a lot of opportunity for investors as well.” 

Record returns in 2018

Overall, 2018 was a record year for the infrastructure sector, boasting records in the amount of capital raised and in distributions or capital being returned to investors, according to the Preqin report. It was also a record year for assets under management for the asset class, hitting $491 billion at year’s end 2018. Capital calls reached $35 billionn in H1 2018, while capital distributions reached $33 billion. This is on par with $83 billion and $77 billion, respectively, in all of 2017, according to Preqin’s data.

Preqin expects growth in the sector to continue this year. “2019 looks very positive for the asset class,” Adefuye said. “It seems that lots of investors have the intent to increase allocation to the asset class, with a portion of investors planning to invest more in 2019 than they did in 2018,” he said.  According to the Preqin research, half of investors surveyed plan to increase their allocations to infrastructure over the longer term, while just 6% plan to decrease their allocations.

Adefuye also noted that in some ways the year-end infrastructure data was “surprising”, because there are clear indications that there is lots of  competition in the market. “At moment, we are seeing very high valuations, raising concerns by  investors and fund managers.”  He noted also that while some investors already have capital dedicated to chasing structured deals, there is a contraction in the amount of deals that were completed in 2018 versus 2017. “It’s a function of the amount of competition and how high valuations are,” Adefuye said. “Investors are not willing to pay for high valuations, and the key reason why we see less is that it’s driven by a concern about return compression.”

The high valuations are also due to the fact that there is a lot of money in the asset class. But that has not deterred investors from seeking to make more commitments in 2019, Adefuye said. “That shows positive sentiment toward the asset class in a full-returns perspective,” he said.  “There has been some compression in returns, but distributions are high and have grown as well, so that continues to make investors willing to make future investments in the asset class,” he noted.

According to the Preqin survey, over half of investors and fund managers find that asset valuations present a key challenge for return generation in 2019. The greatest proportion (35%) find that value-added funds present the best opportunities, a shift from previous years when core strategies have been seen as most attractive.

That said, “Looking ahead, the industry is facing challenges posed by increased competition and higher asset valuations. Investors are looking towards higher-risk, higher-return strategies in search of yield, and fund managers report that asset pricing is higher and opportunities are harder to find,” the report stated.

Global economic environment

The push for higher returns, despite the risk,  will also be dependent on what happens in terms of the global economy. “I think investors will be willing to take those risks if the economy is sound. The push for the higher returns is coming from those riskier value-added opportunistic type investors, but if the economy takes a downturn, which many people think we are on the brink of, we might not see it play out. We will see investors migrate away from risky investments to core-style investments, and they will be willing to take lower returns, because those segments are quite populated,” Adefuye said. There is lots of competition out there, returns are being compressed, but if we are in a situation where the broader economy is in that state, that is where we will see investors seek to invest in infrastructure,” Adefuye concluded.  

Key Infrastructure Trends:

  •  2018 was a record year

2018 was a record year for unlisted infrastructure fundraising, with 68 funds raising a record-high aggregate $90bn in capital.

Assets under management also reached a record high, hitting $491bn as at June 2018 (the latest available data).

  • Infrastructure is poised to see further growth

Half of investors surveyed plan to increase their allocations to infrastructure over the longer term, while just 6% plan to decrease their allocations.

Capital calls reached $35bn In H1 2018, while capital distributions reached $33bn. This is on par with $83bn and $77bn respectively in all of 2017.

As at January 2019, there are a record 207 unlisted infrastructure funds in market targeting an aggregate $188bn in commitments

  • Greater competition could mean the rise of higher-risk, higher-return strategies

A larger proportion (26%) of investors expect lower returns in 2019, than those who expect increased returns (15%).

Over half of investors and fund managers find that asset valuations present a key challenge for return generation in 2019.

The greatest proportion (35%) find that value-added funds present the best opportunities, a shift from previous years when core strategies have been seen as most attractive.

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