Infrastructure and Inflation Sensitivity

Client-Specific Concerns

An international non-life insurer/re-insurer with a growing book of assets sought to identify suitable infrastructure managers as part of their first allocation to private market investments.

This involved capital from two different balance sheets–one solvency sensitive, the other unconstrained—necessitating two different approaches to risk/return and liquidity.

In addition, the investor was concerned about the prospect of higher inflation and the impact of changing societal trends (e.g. net zero and digitalisation) on the infrastructure asset class.

Outcome

• Supporting insurer-specific needs. The solvency-sensitive allocation was more suitable for open-ended infrastructure strategies, given the constraints of the Solvency II framework, while the more risk-oriented balance sheet was appropriate for allocation to value-added closed-end strategies. Researchers assisted the investor—a first-time entrant to this asset class—in understanding of the characteristics of open and closed ended funds and the differences in the types of assets they contain.
• Analysing inflation linkage. Open-ended funds typically target core/core+ assets that deliver predictable cash flows with higher inflation sensitivity (e.g. regulated utilities, operational renewables, PPP assets). The closed-end value-add strategies targeted by the more risk-oriented mandate are more focused on capital gains, with returns contingent on successful exits; while they also claim to offer strong protection from inflation, much of that ‘protection’ is essentially provided by strong double-digit returns as opposed to explicit inflation linkage. The team carried out a close examination of inflation linkages, including: sector focus, the proportion of modelled revenues linked to inflation, the impact of changing inflation on portfolio IRR forecasts, impact on portfolio NAV. It is important to look beyond GP estimates.
• ‘Future proofing’. The investor sought insight into how resilient the strategies were likely to be to ongoing societal changes, mega trends and macroeconomic challenges. Bespoke support was provided in order to interrogate managers’ approaches and provide appropriate analysis to the investor.
• Focusing on combinations: Combination analysis included managers’ positioning with respect to mega-trends and societal changes (mentioned above) as well as more conventional lenses of geography, sector, deal size, risk/return profile and so on. This ultimately resulted in the selection of two mid-market open-ended funds and one first-time closed-ended fund. Between them, they target a variety of asset types ranging from mainstream PPP and utilities through to newer sectors such as smart meters, EV charging, telecom networks and energy from waste.