Building up
We see a combination of surging demand, increasing private investment, underappreciated earnings and falling interest rates as potential positives for infrastructure assets.
Thomas V. Kennedy, Chief Investment Strategist for Global Wealth Management
Harry Downie, Global Investment Strategist
Jay Serpe, Global Head of Alternative Investments, Strategy & Business Development
Building up: How we see infrastructure investment expanding
For decades, the term infrastructure has called to mind toll roads, electricity grids, airports, power and transportation networks—the backbone of an industrial economy.
Today, however, the term also includes new kinds of digital infrastructure, such as data centers needed for artificial intelligence (AI) and assets linked to the energy transition. As this chart shows, more than 65% of infrastructure is now exposed to these high-growth themes because they require so much power.
65% of listed infrastructure is exposed to power demand
% of market cap
Source: GLIO Developed Markets. Data as of July 31, 2024
These long-lived assets tend to offer stable cash flows, making infrastructure attractive as a long-term position that can provide potential diversification and consistent income. We believe investors can be underappreciating the value of infrastructure assets today.
Here’s why: Listed infrastructure companies have grown profits at an impressive 16% annually since 20201, yet the value of an investor’s claim on those profits—their total return—is only 4% annually. The chart below shows this has created a large gap between profits and performance. In other words, we think there are good reasons to believe these assets are underpriced, which can lead to potential opportunity for future growth.
Infrastructure fundamentals have diverged from total return
Index (December 31, 2020=100)
Source: GLIO. Data as of December 31, 2023.
Infrastructure has always offered investors the potential for diversification and income. Now, with the powerful forces of AI and the energy transition serving as tailwinds, we believe it has the potential to reverse its recent underperformance and deliver higher, sustainable earnings growth that will be reflected in asset prices. To understand why, let’s explore three questions:
What will drive the value of infrastructure in the future?
Why we see opportunity now.
What’s held back the total return for infrastructure?
How an infrastructure investment works, and how it impacts pricing today.
What does it mean for investors?
1) What will drive the value of infrastructure in the future?
We believe demand for infrastructure is at the beginning of a period of rapid growth. Data centers are at the heart of this, as they are necessary for AI—requiring more power from cleaner sources, and it’s having a global impact. While the United States is the largest market for data centers, accounting for roughly 40% of the global market, the data center market is growing around the world. In Europe, Latin America and Asia Pacific regions, data center inventory grew between 15% and 22% year-over-year in Q1 2024.2
Three key factors are driving this growth:
833%
Increase in power prices
80%
Of U.S. data centers under construction are already reserved
While the United States is the largest market for data centers, the data center market is growing around the world.
Additionally, the cost of financing these assets is decreasing. The Federal Reserve cut interest rates by 50 basis points in September, and the market is pricing in further cuts that will bring interest rates to about 3% by the end of 2025, down from roughly 5.5% today.6 And that’s not a U.S.-specific phenomenon, as central banks in other countries are also cutting rates. This would reduce the discount rates applied to future cash flows, potentially increasing their present-day value.
2) What’s held back the total return for infrastructure?
Consider an individual infrastructure project such as a wind farm. Builders typically finance these projects by borrowing money, which means taking on debt. For this reason, infrastructure companies have more than double the debt relative to their profits (Debt/EBITDA7) of a typical U.S. company, as shown in the chart below.
But once the wind farm is built, it generates electrical power that the owner sells to the operator of the grid. This income tends to be stable and can be sustained for a long time. As the chart below illustrates, infrastructure investments are about 24 years old, and their incomes are triple the dividend yield of the average S&P 500 company.
Infrastructure has high income, high debt and a long lifespan
Note: Global Infrastructure = Dow Jones Brookfield Global Infrastructure Total Return Index; World Equities = MSCI World Index; Average age is of S&P500 companies and U.S. Infrastructure (Government and Private Structures and Equipment excluding intellectual capital). Source: HaverAnalytics; Bureau of Economic Analysis; Harvard Business Review; Bloomberg Finance L.P. Data as of August 30, 2024.
That reliance on debt becomes a bigger issue when the cost of financing rises. This was easy to see, as the Fed quickly raised interest rates from almost zero to over 5% in 2022–23. U.S. wind power additions fell 30% in 2022 compared to 2021.8
Today, the pricing of this asset class reflects the increased cost of borrowing. However, we believe it overlooks the future values of infrastructure investments based on their expected profits and incomes, and our expectations for further declines in interest rates. This has the potential to drive stronger performance.
We see this as a good time to consider allocating to the space because we believe demand for infrastructure will continue to grow at a rapid clip. We think durable and high-growth themes in AI and the energy transition will support that growth.
3) What does it mean for investors?
We feel infrastructure is uniquely underpriced at present. As noted, we believe the market is underappreciating the strength and durability of the profits infrastructure assets can generate. Investors are just starting to acknowledge the size of the opportunity—on September 17, 2024, BlackRock, Global Infrastructure Partners, Microsoft and MGX announced a $100 billion new investment partnership to invest in the infrastructure needed to support AI.9 With interest rates coming down, we expect this will come back into focus, with total returns potentially beginning to catch up to profit growth. This provides an investment opportunity.
Investors can gain exposure to infrastructure through both listed (public) and non-listed (private) investments. Historically, there has been little difference in the long-term median performance between the two. However, we believe non-listed infrastructure assets may offer slightly more attractive opportunities today due to discounted deal activity, as shown in the chart below. For new capital allocation, non-listed infrastructure provides the potential to deploy fresh capital at favorable valuations, enhancing the overall return potential.
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Definitions of Indices and Terms
Currencies and central banks
- USD—U.S. dollar
- DXY—U.S. Dollar Index indicates the general initial value of the USD. The index measures this by averaging the exchange rates between the USD and major world currencies
- Fed—Federal Reserve
Additional abbreviations
- Bps—Basis points
- DM—Developed Markets
- EM—Emerging Markets
- EMEA—Europe, Middle East and Africa
- GDP—Gross Domestic Product
- HY—High yield
- NCREIF—National Council of Real Estate Investment Fiduciaries
- SPX—S&P 500
- UST—U.S. Treasury note
- YTD—Year-to-date
1 GLIO. Data as of December 31, 2023.
2 https://www.cbre.com/insights/reports/global-data-center-trends-2024.
3 Auction for PJM. PJM coordinates electricity movement across 14 states in the Eastern United States, including Virginia’s “Data Center Alley,” which covers ~20% of the U.S. population and over 40% of its data centers.
4 The longer wait time applies only to large data centers that need more than 100 megawatts of electricity, and won’t affect projects that have already been evaluated. Source: Bloomberg Finance L.P., August 30, 2024.
5 https://www.cbre.com/insights/reports/north-america-data-center-trends-h1-2024.
6 Forward market pricing based on OIS futures. Source: Bloomberg Finance L.P. Data as of September 24th 2024.
7 EBITDA refers to earnings before interest, taxes, depreciation and amortization. It is a measure of profit for a company.
8 Bloomberg New Energy Finance (BNEF) Renewable Energy Project Database. Data as of June 11, 2024.
9 https://www.global-infra.com/news/global-infrastructure-partners-blackrock-microsoft-and-mgx-launch-new-ai-partnership-to-invest-in-data-centers-and-supporting-power-infrastructure/.
