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        What Does the Downward Interest Rate Trajectory Imply for Infrastructure Investors?

        After a decade of continuous growth, private infrastructure had a challenging 2023. High interest rates, an uncertain economic outlook, and geopolitical tensions all weighed on the industry. Asset performance remained relatively stable but the industry faced the weakest fundraising environment in 10 years.

        6 min read
        Alejandra Olivares Rios
        ETF Strategist

        However, as macroeconomic inflationary pressures continue to subside, central banks have more room to start reducing interest rates. The Federal Reserve (Fed), European Central Bank (ECB), and the Bank of England (BoE) have all cut rates at least once, which reduces the financing costs of global infrastructure projects, making them increasingly attractive to investors.

        The longer-term outlook remains strong for the infrastructure sector with growth prospects driven by technological advances, the energy-generation transition from fossil fuels to renewables, and the need for private sector lenders to fund indebted western states’ infrastructure ambitions.

        Why Infrastructure?

        Infrastructure investment refers to the allocation of funds towards the development, improvement, and maintenance of essential physical structures and systems that support economic activities. It encompasses essential sectors such as regulated utilities (water, electricity, gas, renewables) and user-pay assets (railways, roads, airports, communications, ports), which offer compelling investment potential due to their unique characteristics.

        The appeal of listed infrastructure lies in its ability to generate stable income streams. The consistent growth in underlying assets ensures regular dividend payouts that often outpace inflation rates. This income stability can make it an attractive choice for investors seeking reliable returns in varying economic conditions.

        A Challenging 2023

        2023 was a challenging year for private infrastructure after more than a decade of unbroken growth (Figure 1). Performance remained resilient but the industry’s fundraising was at its weakest in a decade. This slowdown has continued into 2024, with $66B raised year to date. High interest rates and challenges in selling assets have affected fundraising activity. Institutional investors will need more certainty on asset valuations for investment activity to rebound and unlock liquidity for the rest of the year.

        Over time, infrastructure has often reacted to increases and decreases in interest rates. The asset class has tended to perform well when interest rates fall (or there is an expectation that they will not rise further, i.e., peak cycle) and fall when interest rates rise (Figure 2). As a result, over the past five years, infrastructure has underperformed the broader stock market largely due to the upward trend in rates since late 2021. However, it has recently begun to recover as investor expectations for declining interest rates have risen.

        As we move forward in 2024, investors continue to value infrastructure for its ability to provide a degree of inflation ‘hedged’ returns, alongside its diversification, income, and correlation benefits.

        A Positive Macro Backdrop for Infrastructure Debt

        Looking at the macroeconomic environment, as inflationary pressures continue to subside, central banks now have more room to start cutting interest rates. For the first time since 2020, in September the Federal Reserve (Fed) cut rates by 50 basis points (bps) to the 4.75% - 5% range. Fed Chair Jerome Powell said the aggressive cut was done out of precaution and “the labour market is actually in solid condition, and our intention with our policy move today is to keep it there.” Looking forward, the Fed’s dot plot had a median forecast of 50 bps of further cuts this year, 100 bps of cuts in 2025, and 50 bps of cuts in 2026. The “longer run” median forecast has been modified up to 2.875% (versus 2.75% prior). The market is now pricing in another 70 bps in cuts year-end, a more aggressive estimate than the Fed’s 50 bps expectation.

        In Europe, inflation has also been coming in lower than expectations compared to one year ago. The ECB lowered its key interest rate in June 2024, reducing the main refinancing operations rate to 4.25%, and cut it again by a further 60 bps in September. Eurozone inflation dropped to a three-year low of 2.2% in August. The BoE also cut its interest rate from 5.25% to 5% in August 2024. Consensus estimates expect 10-year bond yields across the US and Europe to begin declining in 2024 (see Figure 3), which should bring some relief to those concerned about potential financial distress.

        The Longer-term Outlook Remains Strong

        Infrastructure’s investment horizon remains long term in nature, and secular trends will continue to shape opportunities in 2024 and beyond. These long-term secular trends support infrastructure investment returns in the years ahead. While the sector — along with other defensive sectors — was not as much in favour with investors over the past year, this may change if the remainder of 2024 sees a further weakening of the inflationary picture.

        Should market volatility return, investors may again seek the stability, durable cash flows, and dividends that utilities have historically provided. Nowadays, utility stocks trade at a price-to-earnings (P/E) ratio below that of the broader market (see Figure 4). Utility stocks and, consequently, infrastructure assets, should remain an important piece of a well-diversified portfolio, and investors now have a potential opportunity to access quality utility companies at reasonable relative valuations. 

        Furthermore, infrastructure investing offers a unique opportunity to benefit from key trends reshaping our world. The AI evolution is driving an increasing demand for power. In the next five years, consumers and businesses are expected to generate twice as much data as they did over the last decade. To support this, major technology companies plan to invest $1 trillion in data centres, which will significantly increase power needs.

        Another major trend is the shift to clean energy. Infrastructure is crucial for deploying renewable energy sources, phasing out polluting power plants, strengthening energy networks, and transitioning to cleaner fuels. These efforts are essential for meeting global decarbonization goals. A public policy tailwind is particularly prevalent in the US (following the Inflation Reduction Act or IRA) and Europe (following REPowerEU and the Green Deal Industrial Plan).

        Thirdly, demand for private infrastructure lending is likely to increase. The private sector is a vital funder of infrastructure projects in countries still heavily indebted by COVID and Great Financial Crisis bailouts. McKinsey1 has estimated that investment in global infrastructure could total $3.7T annually between 2017 and 2035, but that a funding gap of $5.5T over the same period will have to be funded by private investors.

        An Innovative, Liquid Way to Access Infrastructure

        The SPDR® Morningstar Multi-Asset Global Infrastructure UCITS ETF is an innovative investment strategy that aims to serve as a proxy for infrastructure. With over $1.3B2 in assets, the fund seeks to offer greater liquidity with a proxy exposure to infrastructure. 

        The fund also provides multiple exposures to equities and bonds from different companies that are involved in the infrastructure business. It is well diversified both on the equity and the bond leg, with more than 500 stocks and 2,000 bonds3. Thanks to the mix between bonds and equities, the SPDR Morningstar Multi-Asset Global Infrastructure UCITS ETF has outperformed many other pure-equity infrastructure ETFs. It has the potential to provide both regular income and capital appreciation, thus, serving different purposes: to efficiently implement a tactical asset allocation, a core allocation, or to gain temporary infrastructure exposure for committed but uncalled capital.

        How to Access the Theme

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