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Alternative Investments – Brief Look at Infrastructure as an Asset Class – July 2024

Private Equity firms have greatly expanded their exposure to Infrastructure assets over the past 15 years.  Despite higher interest rates materially reducing “exits” and new capital raises for PE firms, there has been no let-up in the launch of additional Infrastructure funds.  A large number of recent transactions have seen PE firms, perhaps feeling under-sized in the hot Infrastructure space, buying independent Infrastructure fund managers.

This article discusses Infrastructure — increasingly seen as a stand-alone asset class by institutional investors and Family Offices.  We believe there are reasons to be cautious currently, despite strong institutional interest in the asset class.

Emergence as an Asset Class

Infrastructure investments began to attract significant attention in the mid-1990’s, despite having been around as a small asset class for over 30 years.  Early transactions were driven by cash-strapped governments seeking to avoid required expansions or upgrading while monetizing existing assets.  Sales to Infrastructure funds focused on toll highways and bridges and local utilities with regulated returns.

As more dedicated capital was raised post 2009, sponsors diversified across additional assets and geographies.  Sought-after assets in the early years had revenues and/or volumes protected by contract and were often the primary transportation link or water supplier or power generator / distributor in a particular region.  Growth could come from increases in the rate base to meet growing demand.  Returns could also be enhanced through the higher leverage achievable due to perceived safety or defensiveness of the underlying cash flows.

This rationale was then applied to other assets with similar attributes, such as parking lots, pipelines, airports, air traffic control agencies, broadband networks and cell towers.

Investment funds also realized that they could separate infrastructure assets from associated cyclical businesses and thereby surface value.  Examples included power islands carved out of pulp mills or midstream assets (e.g., gathering and transmission pipelines, gas plants) separated from larger energy companies funded with a lower cost of capital than was available to the prior parent company.

More recently, the asset class has expanded to include energy transition and electrification themes, including renewable power generation and related storage assets, data centres and EV charging networks.

Assets owned by dedicated Infrastructure funds have grown at greater than a 15% average annual rate since 2012 to above $1 trillion.   Given the perception of lower risk, investors have been comfortable with lower IRRs than are expected from traditional Buy-out funds, with industry commentators suggesting that Infrastructure funds have earned approximately 10% IRRs, about one-third lower than Buy-out funds.

It has been suggested that returns from “long term” investing (meaning, holding assets that have very limited liquidity over the short to medium term) may enjoy a “illiquidity premium” over more liquid or publicly-traded assets.  Owners are rewarded for holding an asset that many investors do not want to, or cannot, hold.  Some institutions, particularly insurance and pension funds that seek i) to match assets with long-term cash flows to long-term liabilities, and ii) lower-risk assets that may still have equity characteristics, include this illiquidity premium as a rationale to increase exposure to Infrastructure assets.

There are a number of investment themes that support ambitious expectations for Infrastructure spending.  Blackrock, the world’s largest asset manager, suggests that the decarbonization aspirations expressed by governments will require investments that those governments will never be able to fund.  McKinsey estimated meeting zero-emissions will require a $3.5 trillion annual spend.  Letko, Brosseau and Assoc (“LBA”) have suggested that the electrification of the United States’ energy system would lead to a doubling of electricity demand by 2050, following two decades of <1%/year growth.

Within the Alternative investments space, Blackrock believes that infrastructure is second only to private credit in terms of where institutional clients intend to increase their allocations in 2024/2025.  Blackrock enlarged its Infrastructure business recently, acquiring Global Infrastructure Partners for $12.5 billion.

Brookfield, a $900 billion AUM Canadian alternative asset manager, raised a record amount for their Infrastructure fund in Q4 2023.  They see renewable power and energy transition as one of the fastest growing areas amongst Alternative assets.  They identify infrastructure as possessing factors that investors seek: market growth, principle-safety in uncertain times, inflation protected revenues and long-term capital appreciation.

In terms of fund raising, Asia Pacific kept pace with North American and Europe in terms of growth in the middle of the last decade, but has fallen behind of late.  However, KKR just closed a $6.5 bn Asian infrastructure fund.  The fund’s mandate includes power and utilities including renewable, water, digital infrastructure and transportation.

Caution May be Warranted

There is historically a strong relationship between real interest rates and infrastructure sector performance.  There is more than $300 billion in dry powder available, following two years of above average fund-raising and reduced investments.

Commentators are beginning to ask whether rising rates and the large increase in uninvested capital allocated to the asset class might result in funds overpaying or stretching the definition of Infrastructure in order to put capital to work.

The higher-for-longer interest rate sentiment put pressure on infrastructure asset valuations in 2023, highly-levered utilities in particular.  Renewable energy was also hard-hit in 2022 and 2023, as supply chains bottlenecks drove input inflation and higher interest rates made many projects difficult to finance at levels that could generate attractive returns on capital.

We may need a few years to see what higher interest rates will do to the returns generated by traditional infrastructure assets.

Access for Retail Investors

Blackstone introduced new structures that provide high-net-worth individuals access to Private Equity products.  Funds that provided longer-term capital (no wind-up dates) for real estate and private credit were their focus.  Their success motivated competitors to follow suit and we expect similar structures for Infrastructure assets are coming.

However, individual investors can also gain infrastructure exposure through public markets with more modest investments and without the fees charged by private equity.  Publicly-held infrastructure enjoys the same tailwinds as do privately-funded, including to the structural growth drivers of energy transition, electrification and digitization. Many of these companies pay attractive dividends as well as offering growth through expansion driven by demographics.

For example, our client portfolios contain electricity utilities with substantial renewables exposure (EdP from Portugal, Copel – Brazil), water management utilities (Veolia – France, Saneamento Basico – Brazil, China Water), airports (Fraport – Germany, Aeroportuario del Centro Norte – Mexico) and natural gas distribution (Beijing Enterprises).

As another example, 35% of First Pacific’s net asset value is attributed to infrastructure assets located in the Philippines, Indonesia and Singapore, including electricity generation, water utilities and toll roads.

LBA’s Emerging Markets Fund has a 20% allocation to infrastructure assets (including telco companies), to take advantage of the enormous spending on even basic infrastructure required in many emerging markets.

If you would like to know more about these allocations or investment rationale, please let us know.

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Vintage Wine Market Update – April, 2024

Fine wine market – A buyer’s market

Since the beginning of 2023, the fine wine market has experienced a noticeable downturn in all major growing regions. After more than 2 years of strong and steady price growth, it is evident the performance of the fine wine market has been significantly affected by the combination of economic and geopolitical uncertainties. Auction houses have been a victim to these conditions and reported a decline in total sales revenue for 2023. In addition, the reopening of China hasn’t had the expected effect many desired.

UK and Europe have been the strongest markets in 2023, whilst Asian and US buyers have remained cautious. The main question on many minds is has the market bottomed or will price corrections continue. Q1 2024 showed glimpses of stabilization, however, most merchants expect prices to continue dropping.

En Primeur Bordeaux

The Bordeaux 2023 tastings have finished, and the consensus is 2023 will be a good vintage with some remarkable wines. Neal Martin from Vinous has described it as a “Dalmatian vintage”. A vintage which will be approachable at an early stage whilst also offering great aging potential for the top wines.

Left bank Cabernet Sauvignon is set to perform very well especially for vineyards in north Medoc such as St Estephe and Pauillac. Keep an eye out for Montrose, Pontet Canet, Lafite, Pichon Baron and Ducru Beaucaillou in St Julien. Pomerol and Saint Emilion have also produced some outstanding wines thanks to a great quality Cabernet Franc, not to mention Figeac, Cheval Blanc and Eglise Clinet which are among the best wines produced in 2023.

After months of Bordeaux under-performance in the secondary market and abundance of stock available, an attractively priced En Primeur campaign is ultimately what Bordeaux wine merchants and Chateaux should focus on. In these challenging economic times, the Bordeaux En Primeur offers great opportunities for Bordeaux wineries and the trade to focus their attention on the region. So far, Bordeaux wineries have shown some good will and have considerably lowered their release prices compared to the 2022 vintage. Chateau Lafite for example, probably one of the best wines of the vintage, dropped their prices 31% from the previous year to £4920 per 12 bottles.

We have noticed that there is much commentary attempting to link, or correlate, the fine wine market with financial markets, economic developments, and even monetary policy.  This is nothing more than an attempt to lend sophistication to physical assets that have limited production and a constantly dwindling supply as wine is consumed.  It is simply supply and demand, which is driven by increased discretionary income, the latest consumer trends, and weather conditions.

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The Modern HNW Family II – December 2023

Introduction

The Society of Trust and Estate Practitioners (STEP) recently conducted a roundtable discussion, sponsored by Royal Bank of Canada Wealth Management, about how Covid and increased geo-political instability has impacted the concerns and objectives of HNW families.

A core finding is that priorities have shifted, incrementally, away from a focus on cross-border investment opportunities and risk-adjusted returns, to a greater emphasis on asset protection and estate and succession planning, or “future-proofing” the family’s wealth.

Background

Attitudes towards social responsibility and equality have acquired greater significance, especially amongst younger generations.  There is also an increasingly hostile attitude towards wealth and complex, often non-transparent, ownership structures from parts of the media and society.

Advisors often encourage families to discuss the purposes and values of the family and its approach to managing its wealth in hopes of creating a broad understanding.  These discussions may increasingly include the family’s ownership structures (including trusts) and business practices and how that aligns to its purported values and purposes.

Even families with legitimate offshore structures can find themselves defending their purposes because information about the family and its wealth that was once private is increasingly becoming public.

Diverse Attitudes within a Family can Complicate an Advisor’s Approach

The panel highlighted that advisors should not assume that all family members hold similar views, particularly when it comes to evolving social issues.  The conversation about how the family’s wealth will be used can change radically as the views of the younger generation are voiced.  This may, in turn, make the older generation, that may have built the wealth, more anxious about the future, when they will no longer as much influence.

The challenge is seen as creating a culture that can be communicated through education about family purpose with detailed discussion around succession planning options.

An example of how differing principles between generations can directly impact advisors and these processes are issues associated with ESG principles.  Advisors, including Trustees, increasingly must deal with differing views on how to prioritize ESG objectives when evaluating investment alternatives.

This public debate, including pushback from some politicians, and well documented misalignments through lack of standards or green-washing, is already impacting large wealth managers through reputational attacks.

If some family members wish to emphasize ESG-directed investments without regard to conventional expectations of “financial returns”, how do their investment managers respond?  More specifically, how does a trustee or investment managers’ fiduciary responsibilities apply in this case and might they become liable to a beneficiary?

Trustees should ensure that the trust deeds are guiding their investments, rather than their own views about issues associated with ESG.  But what if those matters are not addressed in the trust deed, letter of wishes, or family governance documents?

Lost Privacy

We have elsewhere described the increasing reporting requirements for HNW families.  Some of these are not public, such as CRS-mandated transfers between tax authorities.  But there is an increased likelihood that private information such as wealth, holding structures, succession arrangements become public via registers members of the media or public can access or information leaked to social media.

For families that see privacy as a key part of their own security and safety arrangements, their Advisors should consider how their estate and tax planning is exposing the family to unnecessary public filings and monitor their custody banks and other third parties to ensure that information that is not absolutely required to be shared is nevertheless being shared due to a misunderstanding of the rules or through recklessness.

Impact on Planning Processes

An increased focus on personal safety and asset security can have other more direct impact on NHW families – in terms of mobility and choice of location.

Some people having migrated from Hong Kong is well documented.  But the same concerns has also led some to shift family office assets to another jurisdiction.  Another contributor on the panel noted that Middle Eastern families have an increased interest in greater international diversification of assets because it is difficult to anticipate where instabilities will suddenly arise.

Others noted that places that were once viewed as very stable might be seen to HNW families in China or the Middle East as less so.  The current UK and US political discourse does not increase confidence.

Some wonder what Swiss cooperation in sanctions applied against certain Russian nationals and entities might mean for individuals in China with assets in Switzerland.

A key observation is that when Advisors are revisiting a family’s estate plan, it is not just changes within the family that need to be top of mind in assessing whether the existing plan meets family objectives.  External influences can also cause stress as a family’s attention turns from inter-generational issues, to security issues flowing from regulatory and geo-political changes.

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The Modern HNW Family Part I – October 2023

In 2021, the Society of Estate and Tax Practitioners (STEP) conducted two broad surveys of HNW advisors, sponsored by TMF Group and RBC Wealth Management, centered on the evolving needs and expectations of the “modern HNW family”.

The panel members observed that changing client expectations are being driven by both i) changes within family dynamics, and ii) changes to regulatory regimes and societal impacts. This note focuses on the first of those.

Changing Family Composition is Impacting Objectives

Core findings are influenced by the changing composition of “modern” families. Advisors recognize that their advice and processes also need to evolve as these changes can heighten conflicts between family members with respect to viewpoints and priorities.

An increasing proportion of client families have i) members from a mix of cultural or ethnic or religious backgrounds, and are separated geographically, ii) family members by way of adoption or step-parent arrangements, iii) cohabitating partners, and iv) same-sex partners. These modern, more complex, families are sometimes described as “blended”.

Advisors are finding that differing priorities between the older, perhaps “founding”, generation and the younger generations have become more pronounced than was a case 20 years ago. The trend has been to encourage the older generations to give greater voice to the younger generations, expecting that greater communication will surface areas of conflict that can be addressed early. Bringing these conflicting views into the formal planning process can at times make the older generation anxious about the future or resentful at what they perceive as insufficient respect.

Sometimes, the gap between the objectives of younger family members and the laws of jurisdictions that have been slower to modernize can complicate solutions.

Advisors see increased reliance upon Soft Skills

HNW families have always required advisors with expertise across investment management, tax planning, estate and succession planning, accounting and insurance. This may require expertise across multiple jurisdictions, especially with respect to tax and estate planning.

But families increasingly seek out advisors experienced in family and business governance, inter-personal dynamics, education and communication.

The panel also concluded that while clients require advisors that can deal with complex, multi-jurisdictional issues quickly, they often require that this differs set of experts be able to collaborate with each other effectively.

Many families have found the process to complete a complex tax and estate plan took far too long. Since most professionals charge by the hour, “too long” translates into “too expensive”.

Some family offices are developing regional or global networks of other family offices. This can lead to developing networks of professionals that already have established collaborative, cross-jurisdictional relationships. Such a network may be just as helpful in spotting opportunities as well as threats. But it depends on key members of the consortium having developed good collaborative skills and practices.

We have posted other notes highlighting the increased legal and reporting requirements for families with members and assets in numerous countries.

As you layer on changes occurring within families, it reaffirms the need for families to regularly examine or freshen their estate planning and structures, particularly those related to asset protection and succession planning.

A legacy structure is no longer fit-for-purpose can be many times more costly than the expenses incurred in these re-examinations. The danger is wider than simply being offside new tax and reporting requirements. It is to anticipate and manage differing attitudes and objectives arising within the family, before those develop into real conflict.

In the past, advisors may have seen their value-add as focused on technical issues such as tax planning, international succession planning including multiple Wills, investments monitoring and reporting systems. But STEP’s survey indicates that advisors increasingly see “early and open conversations about succession” amongst the family and across generations along with enhanced communication and education as a key factor in the successful management of changing family dynamics.

Click here to download a PDF version of this article.

Another Nudge Regarding Estate Planning – September 2023

Most everyone with substantial assets is aware that they should have an estate plan; yet fewer than 35% of families have Wills.

Procrastination is the most common excuse.  Some may have concluded that between today and when a Will will be called upon, their life circumstances will be so different that a Will prepared today will be a waste of money and perhaps create confusion.  Others would do it now, if they knew where to start and who to engage for assistance.  Fair enough; if you start down the wrong path or with the wrong advisor, it may become a multi-year process at considerable expense.

Finally, as a practical matter, some couples without children and an estate that is not complex, might argue that the local intestate rules align perfectly with their own wishes (although they may still face Probate).  This is a weak excuse, because putting your mind to your estate plan will almost certainly reveal complications – e.g., how is your spouse going to access that offshore bank or brokerage account quickly when the broker has never heard of them and your spouse only faintly recalls its existence?

Add in one or more children, and it is irresponsible not to have dealt with guardianship.  If you are going to go that far, why not deal with the straightforward bequests as well?

Practical Hurdles

For “high net-worth” families with complex estates, complex family dynamics and/or global assets, there is usually no resistance to seeking qualified professionals to assist them in reviewing or creating a comprehensive estate plan.

Well-written estate planning guides may be a suitable starting place.  However, families considering an estate planning exercise may be put off by suggestions or structures (e.g., trusts) that are expensive to set-up, expensive to maintain, and may still ultimately result in disputes as their family dynamics change over time.

Multiple Wills can be an appropriate response when dealing with real assets situated across differing legal systems.  Again, the cost may discourage some.

Even Family Offices, with no real financial constraints, can find it difficult to round up a team of professionals, with the relevant local expertise, that can actually collaborate and produce a final plan in a timely manner at an appropriate cost.

While this will be heresy to many advisors, it may be that many people are letting the search for a perfect solution stand in the way of at least a helpful solution.  At least chip away at it.  From an earlier post, you should at least consider having:

• a comprehensive list of assets, accounts (with numbers, contact names / #s) kept updated and safe and within reach of your spouse / executor / beneficiary(ies);
• a Will dealing with the major assets, even if it might leave some international rule of law questions outstanding – at least your intentions will be known;
• Thought about practical steps outside of a Will – e.g., where appropriate, change bank / investment accounts to jointly-held or add designated beneficiaries, ensure insurance contracts are up to date, execute durable Powers of Attorney.

Take a few minutes to imagine how everything is going to work out if you were to pass unexpectedly.

Is someone going to inherent an asset with a liability (including a tax liability) without the ability to pay that tax without selling the asset.

This could happen with large real estate properties or shares in a family business.  Many countries have an inheritance tax regime.  While smaller estates are often exempted, you should consider whether your plan, or no plan, will generate significant taxes for your beneficiaries or estate.

You may have to incorporate life insurance into a trust, or identify certain beneficiaries, in order to allow the smooth transfer of assets.

Practical Problems

Even having developed a good estate plan may not be the end of it.  You need to review the plan periodically, particularly after major life events, to see that it still holds together and would meet your aspirations.

Many couples have made arrangements to avoid Probate by having all major assets, including bank accounts held as joint accounts or with a named beneficiary where applicable.  Then, in a moment of carelessness, a new account is created that is not jointly held and this, upon passing, pushes that part of the Estate into probate (if it is material) and holds up or complicates the financial plan for a period.

Older couples anticipating one or both becoming incapacitated prepare Power of Attorney’s — giving the other spouse or a younger family member broad authority to act on their behalf.  Even when properly prepared, your bank might be unprepared to accept instructions under the PoA.  Many bank employees are not well-trained in dealing with family members armed with PoAs.

On top of everything else going on with the passing of a parent, the time wasted simply getting instructions acted upon or gaining access to funds, can be very frustrating; especially when prudent planning was put in place.

If the PoA is there to protect an older family member that is at risk of become incapacitated, consider taking that person, along with the PoA, into the bank and meet the manager and explain the purposes before incapacitation occurs.

We do not provide estate planning advice and therefore have no real iron in the fire – in terms of fees or type of outcomes.  But we deal frequently with client worries and discomforts about a wide range of issues impacting what they will leave for their family.  While there are risk management approaches to dampen financial market uncertainties, risk on ultimate returns remains.  However, it would be a shame to have addressed those risks and costs that are controllable through an appropriate estate plan.

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