UBS Asset Management

The infrastructure
equity cycle
Infrastructure white paper series | Part 3

Institutional investor
interest in the
infrastructure sector
is at record highs.
This paper takes a
closer look at the
impact on valuations
and examines where
we are in the cycle.

Declan O'Brien | Alex Leung

Real Estate & Private Markets,
Research & Strategy
The infrastructure equity cycle: where are we now?

This is the final installment of our infrastructure white paper series. Our first paper,
The case for infrastructure debt (click here ), provided a closer look at the growing
area of infrastructure debt. The second, Infrastructure and the economy (click here),
explored how infrastructure returns might perform under various economic scenarios,
particularly in a rising interest rate environment. This paper will examine where we are
in the infrastructure equity cycle, in terms of investment style and valuations, and
opines if the two are linked.

Introduction Institutional investors' allocation to private assets has

Infrastructure equity is now an established asset class in
institutional investors' portfolios making up around 3%1 of
total AUM. Fundraising in the infrastructure sector set a new
record in 2016 of USD 66 billion, surpassing the USD 49
billion raised in 2013. This momentum continued in 2017
which saw USD 65 billion raised.
Investor sentiment is at record highs: according to Preqin2,
93% of investors surveyed felt infrastructure had met or
exceeded their expectations; 90% expect to deploy the same
or more capital in the next 12 months.
increased by 9% 2 p.a. (2010-2017); infrastructure was the
asset class that recorded the strongest growth of 16% p.a.
The attractiveness of infrastructure has been driven by its
strong returns in a low-yielding environment.
As with other private asset classes, the level of dry powder is
at record levels as demand for high yielding assets exceeds
investment opportunities. The step change in fundraising
volumes in 2016 and 2017, and the rise of the mega-fund3
has also contributed to the level of dry powder in the sector

Chart 1: Growing infrastructure AUM

(AUM, USD billion)

450

400

350 150
148
300
109
250 106
110
200
75
86
150
68 268
238
100 216
67 64 190
146 165
65 125
50 94
51 62
34
0
2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Unrealized value/ invested Dry powder

Source: Preqin, 2018 Preqin Global Infrastructure Report

1
OECD (2018), Survey of Large Pension Funds and Public Pension Reserve Funds, 2016 2
Preqin, 2018 Preqin Global Infrastructure Report
3
Fund size of > USD 2 billion, Preqin

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Evolving investment style
The growth of the infrastructure sector means that investors
now have a choice of managers across the risk-return
spectrum. As the real estate nomenclature of core, core-plus,
value-add and opportunistic is now firmly embedded in the
infrastructure sector, we set out below an illustration of the
typical return composition of each strategy.
Note on the MSCI Global Quarterly Infrastructure
Asset Index:
The MSCI index is calculated in local currency and weighted
towards Australia: 45% allocation as at December 2017.
Risk-free rates in Australia over the past five years have
exceeded the G7 average by around 1.5%, resulting in
higher overall returns versus a USD-denominated index.

Chart 2: Illustration of typical return split by strategy

Interestingly, while the one-year return profile in chart 3
provides a strong risk-reward relationship, chart 4 shows a
weaker link over a longer period with higher-risk strategies
Income Capital Volatility of demonstrating more volatile returns.
Style
component component returns

Chart 4: Historical returns by style

Core (Return p.a. %, local currency)

25.0
Core-plus

20.0
Value-add
15.0

Opportunistic
10.0
Source: UBS Asset Management, Real Estate & Private Markets, 2018

5.0
The illustrative returns above align well with the actual one-
year return composition from the MSCI index split by style 0.0
below. 1yr 2yrs 3yrs 5yrs
Low risk Moderate risk High risk

Chart 3: Composition of historical returns by risk style Source: MSCI Global Quarterly Infrastructure Asset Index, December 2017
(12-month return (%), local currency )
The rise of the mega-fund has contributed towards the record
25.0 fundraising and dry powder in the sector. Many mega-fund
managers were traditionally private equity players and this
may also be a contributor to the increasing percentage of
20.0 non-core strategies as shown in chart 5 below.

15.0

10.0

5.0

0.0
Low risk Moderate risk High risk

Income return Capital return

Source: MSCI Global Quarterly Infrastructure Asset Index, December 2017

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Chart 5: Changing investment style Chart 6: Composition of returns by risk style
(Capital raised by primary equity strategy, %) (Quarterly return, %)
7.0
100% 4%
8% 7% 9% 7%
16% 15% 6.0
90% 10%
17% 20%
80% 18% 39% 5.0
23% 24%
70% 49%
24% 4.0
60%
50% 65% 46% 3.0
51%
40% 39% 39% 2.0
45%
30% 32%
51% 1.0
20%
30% 0.0
10% 22% 23% 21%
16% 18%
12%
0% (1.0)

Jun-08
Dec-08
Jun-09
Dec-09
Jun-10
Dec-10
Jun-11
Dec-11
Jun-12
Dec-12
Jun-13
Dec-13
Jun-14
Dec-14
Jun-15
Dec-15
Jun-16
Dec-16
Jun-17
2010

2011

2012

2013

2014

2015

2016

2017

Core Core-plus Value-add Opportunistic Income return Capital return

Source: MSCI Global Quarterly Infrastructure Asset Index, December 2017 Source: MSCI Global Quarterly Infrastructure Asset Index, December 2017

The impact of the growing share of non-core strategies in the
infrastructure sector can be seen in the 2017 total return from
the MSCI index which consisted of approximately 60% capital
return and 40% income return.
This suggests that the infrastructure sector is moving more
towards the core-plus, value-add style than core. This may also
indicate that the sector is experiencing some style drift, with
managers seeking riskier transactions to meet stated return
targets as returns have compressed.

Correlation with other asset classes

As outlined in our previous white papers, one of the key features of the infrastructure asset class is a historically low correlation
with other asset classes as shown in chart 7 below.

Chart 7: Low historical correlation between infrastructure and other asset classes
(Correlation coefficients (4Q07-4Q17)

Equities Government Bonds Corporate Bonds Listed Private

Infrastructure Infrastructure
(2Q lag)

Equities 1.0 - - - -

Government Bonds -0.4 1.0 - - -

Corporate bonds 0.5 0.2 1.0 - -

Listed infrastructure 0.8 -0.1 0.7 1.0 -

Private infrastructure (2Q

0.3 -0.1 0.0 0.3 1.0
lag)
Source Equities: MSCI WORLD ; Government bonds: JPM GBI GLOBAL ALL MATURITIES; Corporate bonds: ICE BofAML Global Corporate Index; Listed infrastructure: DJ
BROOKFIELD GLB INFRA (USD); Private infrastructure: MSCI Global Quarterly Infrastructure Asset Index.

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The overall private infrastructure sector shows a historical However, as infrastructure investors become more aggressive
correlation coefficient with listed equities of 0.3, once we with their investment style, the riskier "infrastructure"
apply a lag of two quarters. Public markets price daily based investments perform more like public or private equity
on market fundamentals whereas the private market relies on investments, where capital appreciation tends to make up a
semi-annual or annual valuations. Therefore, we believe that large part of returns.
by applying a lag, the results are more closely aligned with
reality than showing the unlagged correlation coefficient with Riskier infrastructure investments therefore become correlated
equities of 0.02, noting that both methods have limitations. with other risky assets, which means an investor loses some of
the diversification benefits from investing in infrastructure in
While we don’t have robust data for core strategies, we the first place.
believe that an income stream from low-risk, stable assets
would have an even lower correlation with traditional asset Valuations
classes. From a diversification perspective, adding low Many commentators have incorrectly called the top of the
correlation assets to an existing portfolio improves risk- market over the recent past. Rather than trying to predict
adjusted returns, as measured by the Sharpe Ratio. when valuations might peak, we set out some late-cycle
signals and critically assess the differences from previous cycles
to provide some insights. Chart 8 shows the evolution of
infrastructure valuations from 2004 to 2017.

Chart 8: Late cycle - Valuations expensive by historical standards but returns offer significant premium to bonds
(EV/EBITDA multiples) (Bond rate,%)

18x 10%

16x 9%

8%
14x

7%
12x
6%
10x
5%
8x
4%
6x
3%

4x
2%

2x 1%

0x 0%
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Jan-17
Jul-04

Jul-05

Jul-06

Jul-07

Jul-08

Jul-09

Jul-10

Jul-11

Jul-12

Jul-13

Jul-14

Jul-15

Jul-16

Jul-17

Trailing 12M Avg EV/EBITDA (left axis) Trailing 12M Median EV/EBITDA (left axis) 10-year bond (G7 average, right axis)

Source: UBS-AM Proprietary Database, Mergermarket, InfraNews, Infrastructure Journal, Infrastructure investors, Bloomberg; August 2018

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Looking at the EV/EBITDA multiples in chart 8, valuations
appear to be close to 2007 levels; however, the risk-free rate
in late 2007 was around 4% versus circa 1.5% today. This has
implications for both the cashflow of an infrastructure asset
and the attractiveness of the asset class.
Conclusion
The infrastructure sector has proven itself as an attractive asset
class by providing diversification and strong returns. We
believe that infrastructure will continue to provide strong
returns and play an important role in investors' portfolios.

Infrastructure assets are typically highly leveraged so the
impact of lower rates on an infrastructure company's cashflow
can be material. However, as EBITDA is calculated pre-debt
service, the EV/EBITDA multiple does not adjust for the impact
of lower rates making the over-time comparison less
meaningful.
The low yield environment has contributed to the
attractiveness of private markets with investors seeking to
capture the premium which private markets can offer.
Infrastructure has further benefitted from its strong
performance (see chart 3). The increased interest in the asset
class has led to return compression; however, relative to risk-
free rates, which have also been falling, infrastructure
continues to provide an attractive premium.
High valuations are a topical theme across all public and
private equity markets as cheap money has driven up asset
prices. Private equity data published by McKinsey4 show that
EV/EBITDA valuations increased by 1.9x from 2009-2017
versus a 1.2x5 increase in infrastructure multiples. This makes
infrastructure look attractive on a relative basis.
Our proprietary database is robust containing more than
1,000 data points. The availability of data in private markets is
limited so we have created an aggregate index to show the
overall trends. The limitation of an aggregate index is that the
data could be skewed by changing sector composition over
time; however, this would only have a meaningful impact if
the change concerned a switch to or from assets with above
or below average multiples.
However, the record fundraising in the sector has also led to
an increasingly competitive market, fuelling rising valuations.
In our view, these inflows have also contributed to a change in
investment strategies. The sector has become more focused
on non-core strategies, many of which rely on capital growth
to meet return targets. We believe that these strategies are
more highly correlated to other private and public equities,
meaning that investors will lose some of the portfolio benefits
of investing in infrastructure.
There are warning signs that we are late in the cycle:
managers are adopting riskier strategies and valuations look
expensive by historical standards. However, we believe that
some of the uplift in valuations can be justified by a lower
rates environment. Additionally infrastructure still provides a
significant premium over risk-free rates and looks attractive
relative to other private asset classes.
These nuanced arguments highlight the risks around calling
peak valuations with some worrying signals offset by other
credible mitigating factors. So, while we can't pinpoint where
we are in the cycle, we believe that if there is a market
correction, income strategies would outperform capital-driven
strategies as the income from stable infrastructure assets will
continue delivering returns for investors.

Attractiveness of the asset class

The attractiveness of the asset class is an important
consideration in the trajectory of valuations. The infrastructure
asset class is around 4x larger now than in 2007 and these
flows have contributed to asset price inflation.

There is a growing secondary market for infrastructure assets,

which has supported the strong overall performance of the
sector. As capital-growth strategies are reliant on successful
exits to meet return targets, a healthy secondary market
supported by strong liquidity from new inflows is paramount.

While the outlook for the sector is very positive, with

sentiment for the asset class at record highs, markets face
headwinds with the ongoing withdrawal of quantitative
easing and rising rates. We have already seen some
consequences of this with a return of volatility in the public
markets. Capital-growth strategies that are more correlated to
the public markets could be less attractive in the event of a 4
McKinsey Global Private Markets Review 2018
5
UBS-AM Proprietary Database
market correction.

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Page 7 of 8

Infrastructure Research and Strategy
Declan O' Brien
Alex Leung
For more information please contact
UBS Asset Management
Infrastructure Research and Strategy
Declan O' Brien
+44-20-7567 1961
declan.obrien@ubs.com
Follow us on LinkedIn
www.ubs.com/infrastructure
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