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2023 Institutional Infrastructure Allocations Monitor

Global Institutions are Meaningfully Under-Invested in Infrastructure Relative to Target Allocations, Finds Inaugural Infrastructure Allocations Monitor from Hodes Weill and Cornell University’s Program in Infrastructure Policy

Institutions are under-invested by an average of 98 basis points as compared to target allocations, which should accelerate the pace of sector investments over the next several years

The Americas region is furthest behind, currently, 152 basis points under-invested with expectations to raise targets in 2024

Three-year average returns across institutions stood at 10.7%, exceeding target return levels by 141 basis points

Interest rates and market volatility were cited as top concerns for infrastructure investing

Infrastructure opportunities in North America are expected to lead allocations, driven by the Inflation Reduction Act of 2022

Energy transition is a core focus, with 40% of respondents indicating they expected to increase allocations to renewable energy and storage

NEW YORK (June 29, 2023) – While institutions have become increasingly cautious over the past several quarters in the face of heightened market volatility and denominator effect concerns, sentiment towards private infrastructure remains relatively strong and institutions are still trailing their infrastructure target allocations, according to the inaugural Institutional Infrastructure Allocations Monitor released today by Hodes Weill & Associates and Cornell University’s Program in Infrastructure Policy. On average, global institutions are under-allocated to the asset class by 98 basis points relative to their targets, supporting expectations of increased capital flows into the sector.

Overall, 60% of respondents are under-allocated to infrastructure, with Americas-based institutions the furthest behind at an average of 152 basis points below targets. They are followed by institutions in the EMEA and APAC regions, at 82 basis points and 42 basis points under-invested, respectively. Even considering sizeable infrastructure programs such as the Inflation Reduction Act (IRA) and the Infrastructure Investment and Jobs Act (IIJA) that were signed into law in the U.S., governments across the globe remain limited in their ability to close what has been an increasingly widening infrastructure investment gap. Consequently, there is a growing opportunity for private sector involvement that aligns well with the under-allocation of institutions globally.

To download the full report, please visit: www.hodesweill.com/research.

The 10.7% three-year average return across all institutions exceeded target return levels of 9.3%, reflecting both the critical nature and resiliency of infrastructure in what has been a turbulent period that has been complicated by COVID-19, rising inflation and interest rates, heightened geopolitical tensions, and supply chain pressures. When looking year-over-year, infrastructure portfolios generated an average investment return of 14.4% in 2022, representing a significant rebound from performance in 2021 of 6.9%.

Key to many investors’ desires to add resiliency to their portfolios is their ability to gain exposure to higher-returning infrastructure strategies within their private markets allocation, providing similar returns to other alternatives with less correlation to short-term market volatility. As such, institutions are gravitating towards higher-risk core-plus and value-added infrastructure strategies, while a rising interest rate environment has posed a challenge to the relative attractiveness of super-core and core strategies and driven an expected decrease in investments in these strategies for the foreseeable future.

Mark Rudovic, Principal and Head of Real Assets at Hodes Weill said, “Despite systematic risk in the form of the denominator effect plaguing private markets allocations over the last 12 months or so, sentiment towards infrastructure amongst allocators remains positive given the resiliency of performance through a rising interest rate environment, heightened geopolitical tensions, high inflation, and global supply chain challenges impacting all verticals of infrastructure. Infrastructure remains a particularly favored asset class for institutional investors, and the inflationary risks affecting other asset classes drive capital to infrastructure as a safe haven, as asset owners are often able to pass through rising costs, demonstrating resilience in the face of a slowing economy.”

When evaluating performance based on the size of the institution, there was a marginal difference in the three-year average return, demonstrating the role infrastructure can play as a portfolio stabilizer for institutional investors of all sizes. This return performance could also explain why 43% of institutions expect to increase their target allocations to infrastructure over the next 12 months. However, it’s important to note that infrastructure is a relatively nascent sector for institutional investment especially in the United States, with some institutions just now setting formal allocation targets to the asset class. With this in mind, the expected increase in target allocations could be a conservative data point, especially if performance within the asset class continues to hold up throughout 2023.

When asked to which regions investors expect to allocate capital for infrastructure investments, roughly 34% expect to grow allocations to North America, followed by Europe at approximately 21%. Expected growth in North America could largely be driven by the Inflation Reduction Act of 2022, a first-of-its-kind legislation and the single largest investment in climate and energy in U.S. history. Interest in North America is strongest from EMEA investors, where approximately 44% of respondents indicated a desire to invest more capital in the region.

Of the subsectors within the asset class, institutions indicated that they have the greatest appetite for digital infrastructure, and the proliferation of cloud-computing, enterprise modernization, advancements in AI applications, and mobile apps has underscored an accelerating need for expanded digital infrastructure globally. Despite this rising appetite and need, digital infrastructure represented just 8% of the capital raised by sector-specific funds in 2022. One potential explanation for the discrepancy could be the lack of historical exposure to the asset class as compared to other sectors. The lack of investment through sector-specific funds could also be an indication that investors are comfortable accessing digital infrastructure exposure through diversified strategies.

Renewable energy and new energy transition infrastructure are also top destinations for institutional capital, with 40% of respondents indicating intentions to increase energy-related allocations to renewable energy and storage, which were responsible for 55% of the $40 billion raised for sector-specific infrastructure in 2022. This indicates a preference for specific funds given the critical need for domain expertise in the renewable space. A similar number of institutions surveyed – 39% – reported an intention to increase investments in new energy transition, which includes green hydrogen and carbon capture, among other asset types. Conversely, roughly 76% of those surveyed noted they are either not investing or investing less capital in oil and gas, though institutions in the Americas predicted a modest 7% increase in investment to the asset type.

Dr. Rick Geddes, Founder and Director of Cornell University’s Program in Infrastructure Policy, said, “Broadly speaking, the results of the Inaugural Infrastructure Allocations Monitor from Hodes Weill and the Cornell Program in Infrastructure Policy indicate that institutions have a growing preference for nascent but stable markets with significant expansion potential. The finding that North America is far behind in terms of under-investment suggests that institutions are looking for markets with well-developed contract enforcement, much room to grow, as well as established managers. That is consistent with the investment need in those markets, where aging infrastructure suffering from years of deferred maintenance stands to benefit from large infusions of fresh public spending.”

63 institutions from 16 countries participated in the inaugural survey, representing aggregate AUM exceeding US$6.8 trillion and portfolio investments in infrastructure totaling approximately US$325 billion.

2023 Institutional Real Estate Allocations Monitor

Institutional Target Allocations to Real Estate Remain Flat for the First Time Since 2013 while Conviction in the Asset Class Increases in Anticipation of Attractive Buying Opportunities, Finds Hodes Weill & Associates and Cornell University

Average target allocations remained at 10.8%, marking the first time in the survey’s history that target allocations did not increase

While the majority of institutions are at or over target allocations to real estate, portfolios are beginning to come into balance as the denominator effect abates

Anticipating a more favorable investment environment, investor sentiment has rebounded to its second-highest level since 2013

After retrenching and turning their focus to domestic strategies, institutions are planning to increase cross-border investments, with the U.S. remaining the preferred destination

NEW YORK (November 2, 2023) – Amidst the backdrop of a tumultuous economy, rising interest rates and frozen transaction markets, institutional target allocations to real estate have remained flat for the first time in 10 years, at 10.8%, finds the 11th annual Institutional Real Estate Allocations Monitor, published by Hodes Weill & Associates and Cornell University’s Baker Program in Real Estate. Institutions have chosen to spend 2023 focused on managing their existing portfolios in an environment in which investors are waiting for valuations to find a bottom. While the survey finds that institutions expect to hold target allocations steady in 2024, investors believe the next few years will prove to be good vintage years to capitalize on expected dislocation and distress.

To download the full report, please visit: www.hodesweill.com/research.

The majority of institutions are at or over target allocations to real estate, with nearly 40% of survey respondents reporting overallocation to the asset class by an average of 200 basis points, in comparison to 32% of institutions in 2022 by an equal margin. However, while the denominator effect has been in play since early 2022, there are signs it is beginning to abate, bringing portfolios back into balance. This can be attributed to a rebound in public equities from a low in September 2022 combined with write-downs of private real estate portfolios. The survey notes that there are early signs that institutional portfolios have been trending towards allocation targets over the last several quarters, with institutions responding to the survey after September 1st reporting being under-allocated by an average of 70 basis points.

The “Conviction Index” in this year’s survey, which measures institutions’ view of real estate as an investment opportunity from a risk-return standpoint, increased from 6.0 to 6.4 – its second-highest level since the survey launched in 2013. The rebound in sentiment can be attributed to increasing optimism that compelling buying opportunities will emerge as valuations find a bottom. To that end, investors are starting to deploy capital to select opportunities after an extended period on the sidelines, though they remain cautious, citing concerns relating to further devaluations as interest rates remain higher for longer, and uncertainty regarding macroeconomic fundamentals, including the potential for a recession.

In 2022, institutions saw real estate portfolio returns moderate to 9.5%, following an exceptionally strong performance in 2021 when institutions reported the highest returns generated over the past decade, at 17.1%. This return is consistent with historical averages and is 100 basis points above institutions’ average target return of 8.5%. Survey respondents expect further declines, and potentially negative returns, in 2023 as portfolios continue to take write-downs.

Douglas Weill, Managing Partner at Hodes Weill & Associates, said, “While target allocations are flat year-over-year, this follows ten years of increases totaling 190 basis points, which represents an increase of over 20%. Moreover, the industry has consistently outperformed relative to target returns over the long-term. Despite short- to medium-term macroeconomic disruption, investor conviction in the asset class remains near its high, and the asset class continues to play an important role in institutional portfolios alongside other alternative allocations including private equity, private credit, and venture capital. From a macro perspective, the looming wall of debt maturities may be the catalyst for valuations to find a bottom, encouraging investors to return from the sidelines.”

Institutions in the Americas expect to hold target allocations flat over the next 12 months, and EMEA-based institutions, with the highest target allocation at 11.5%, indicated an intention to lower target allocations by 20 basis points. A substantial portion of this decline is out of Europe, where nearly 20% of institutions report an intention to lower target allocations. The APAC region was the only one to report an anticipated increase, with target allocations expected to rise 50 basis points from 9.5% in 2023 to 10.0% in 2024.

The United States remains the preferred destination for capital allocations from both North American and international investors, with 89% of institutions reporting they are actively investing in the region, followed by 73% in Continental Europe, 65% in the United Kingdom, and 41% in Asia. Approximately 45% of institutions expect to invest the same amount of capital in North America in 2023 (up from 38% in 2022), while 23% expect to invest more capital in the region. Australia also saw a marked increase in institutional demand year-over-year, from 30% to 41%, matching Asia in terms of investor appetite. Notably, after retrenching and turning their focus to domestic strategies given the uncertainty in the market, institutions are planning to increase cross-border investments.

Despite a sluggish fundraising environment that has persisted since 2022, more than 80% of institutions report that they are now actively considering investments in funds. Faced with overallocation, institutions report that a majority of investments (64%) are expected to be allocated towards existing manager relationships, and only 11% of institutions are willing to invest with first-time fund managers, down from 16% last year.

As it relates to risk preference, higher-return strategies continue to be the focus, with over a quarter of institutions expecting to invest more in both opportunistic and value-added strategies. Investors are also showing an increased appetite for credit strategies, with 34% of survey respondents noting they are planning to invest more capital in real estate debt, up from 14% in 2022. Furthermore, approximately 42% of institutions are planning to invest more capital in REITs to complement their private real estate portfolios, with 55% of REIT investors citing liquidity as a primary objective.

Institutions are continuing to emphasize the importance of ESG when making investment decisions, and investment managers continue to reposition their organizations and product offerings in response. This year, approximately 58% of institutions indicated that they have a formal policy in place, up from 56% in 2022 and 32% in 2016. However, the impacts of those policies on investment decisions vary by region. European institutions continue to lead the industry, with 89% responding that their investment decisions are influenced by ESG policies, compared to 28% of institutions in the U.S., where the political climate around ESG is more complicated.

175 institutions from 25 countries participated in this year’s survey, representing aggregate AUM exceeding US $10.2 trillion and portfolio investments in real estate totaling approximately US $1.1 trillion.