Good news is bad news again. U.S. interest rates dropped another 25 bps to close out 2024, but the Fed governors’ widely varied views on future rate cuts sent public markets tumbling at the end of last year. While the “hawkish cut” took the steam out of the rate-sensitive public market indices, the continued momentum of private infrastructure investments in the U.S. will persist, regardless of any potential monetary or federal policy changes. In fact, the asset class’s history of outperformance when macroeconomic conditions hinder others drives our belief that private infrastructure shares a lot more in common with Isaac Newton's first law of motion—objects in motion stay in motion—than his third—that every action has an equal and opposite reaction.
In the private markets, critical infrastructure projects like data centers, telecommunications towers and renewable-energy generation assets have continued to accrue capital and produce historically favorable returns as the megatrends supporting them have progressed. We believe the long-term macro tailwinds behind these trends will continue despite potential changes to federal policy overlays that may impact them on the margins.
In fact, we believe that the risk of policy changes and any impact they may have on infrastructure assets is overstated. Some types of infrastructure investments will simply stay in motion, namely AI, data centers and renewable energy infrastructure. Advisors and their clients would do well to take note of this part of the private markets when revisiting portfolio allocations for the year ahead.
Private Markets and U.S. Policy
In the U.S., there is a massive need for new infrastructure initiatives to support a growing population, expanding economy and the social well-being of our country. Private investors can help fill this gap and be positioned to benefit from a strategy that has historically delivered good, steady returns.
As a percentage of GDP, the U.S.’s average annual public infrastructure investment is only 1.54% (source: Global Infrastructure Outlook, Global Infrastructure Hub), less than half of what other G20 countries spend on developing the critical assets that make modern living possible. Looking ahead, the investment gap between projected spending and projected infrastructure needs is estimated to reach $3.8 trillion by 2040 (source: Global Infrastructure Outlook, Global Infrastructure Hub). Federal policy changes—in either direction—cannot address this gap alone. Nor should they. There are many verticals in which private capital is better suited to develop the types of infrastructure that can move the U.S. forward. And the federated nature of state policy makes sweeping federal changes unlikely.
There are three critical things for advisors to keep in mind when assessing private infrastructure and the potential impact of federal policy changes in the United States.
- While federal policy can certainly influence the outlook, other market forces, including supply and demand dynamics, it is consumer preferences and asset level economics that have and will continue to drive capital formation in infrastructure.
- Good government policy seeks to incentivize behaviors and drive investments into key sectors that may be less economically appealing for private investors otherwise.
- The Bipartisan Infrastructure Law and the Inflation Reduction Act (IRA) both received political support across the aisle and are now codified into law, benefitting blue and red states alike. So, while President Donald Trump may make some sector-specific changes to the IRA, we believe that large structural changes are unlikely.
That said, with market forces, consumer preferences, and asset economics already aligned around critical infrastructure themes like AI and renewable energy assets, some measures are likely to change, while others will stay the same.
Why Infrastructure?
In the last 24 years, investor interest and new private infrastructure investment strategies have helped the asset class increase its market cap by nearly 320x, growing from about $5B in 1999 to $1.3 trillion in 2023, which reflects a 26% CAGR. That’s the type of growth that advisors should get excited about. On a 10-year risk-adjusted basis, infrastructure has consistently outperformed its public market equivalents (PMEs), including REITs and the DJ Brookfield Global Infrastructure Index.
Staying the Course
We believe that the current production and tax credits will stay in motion. These have been in place since 2005 and have been repeatedly renewed by both parties since then. Moreover, any potential change to these credits would be immaterial. A lack of federal credits or subsidies does not drive asset economics today; it can help them on the margins, but in the absence of these programs, it simply means that higher power purchase agreement (PPA) prices are passed onto off-takers. This type of pass-through is great for investors. On the flip side, the presence of federal tax subsidies does not drive project economics. These subsidies can be additive to infrastructure investments at the margins but do not drive deals.
For example, we recently sold a renewable energy company alongside a specialist sponsor in the private energy space. This deal generated a 30% IRR. The deal sponsor estimated that 100-150 bps of that IRR was a result of IRA tax credits. 1-1.5% on a 30% return isn’t a driving force, and the project had already attracted significant capital pre-IRA. In other words, it was a good investment. We expect these types of infrastructure investments to continue their forward trajectory.
Another driving force is power demand, which is accelerating in the U.S. for the first time in a very long time, largely because of the skyrocketing need for AI and data center. We expect this megatrend to continue increasing power prices and incentivize all forms of generation to become more economical. Investors are excited about this growing trend and advisors getting them into favorable deals can help meet the demand.
Course Correction?
Now, what’s likely to change? Let’s start with the IRA. Electric vehicle (EV) tax credits are likely to be reviewed. However, because the cost differences between electric and internal combustion engine vehicles are not nearly as extreme as they once were, there is much less reliance on federal credits or subsidies to drive consumer behavior.
The potential to lift the ban on LNG exports is now higher with the new administration’s perspective on oil and gas. If acted on, more LNG exports will likely increase gas prices (and therefore wholesale power prices), which would benefit all forms of generation, including renewables. With deregulation now back in the picture, easing the permitting and the environmental review process across the energy complex could benefit grid improvements and interconnections, which have been a bottleneck in new energy generation sources, especially as data center demand grows.
While past performance is never an indicator of future success, key attributes of private infrastructure investing differentiate it from other asset classes. Many of these attributes are appreciated by investors seeking risk-adjusted returns, including downside protection, inflation hedge potential, and yield as a component of total return.
Add to the equation that federal policy is not driving interest in or capital formation around private infrastructure development in the U.S., and the case for investment becomes even stronger for advisors and investors alike. By including infrastructure in a portfolio, advisors and investors can put capital to work without facing many of the headwinds (like rate sensitivity) that other assets face.
These enduring attributes have continued to move the asset class forward through different economic cycles over the course of many decades, and we believe that this investment trajectory should continue. The private infrastructure investment strategies that are in motion today will, as Newton says, stay in motion, which we consider a win for advisors, investors and U.S. infrastructure more broadly.
Footnotes: As of March 31, 2024.
Brent Burnett is head of infrastructure and real assets at Hamilton Lane.
