Unlocking Yield: Sovereign Wealth Funds Shift Towards Direct Infrastructure Investments

Over the past five years, sovereign wealth funds have increasingly turned to direct infrastructure investments to diversify their portfolios and achieve long-term returns.

In 2018, their direct investments in infrastructure accounted for $6 billion, representing 13% of the annual total. However, by 2022, this figure had risen to over $17 billion, or 25% of total investments.

According to McKinsey’s latest Global Private Market Review 2023, not only did direct investments grow, but as infrastructure and natural-resource asset managers overcome broader market headwinds, they set a new fundraising record of $158 billion. The closing of a record number of global megafunds boosted fundraising. Assets under management reached a new high of $1.3 trillion, 14.2% higher than in 2021.

Why the shift? Infrastructure investments provide stable cash flows, inflation protection, and a hedge against economic volatility, making them an attractive option for long-term investors. Additionally, many developing economies are investing heavily in infrastructure to spur economic growth and development, providing ample opportunities for sovereign wealth funds to invest directly in projects and assets, often investing alongside their peers. Those opportunities are not only in developing countries, but they are becoming increasingly common in developed markets, too, as they gear up towards the energy transition in light of the conflict in Ukraine and to strengthen their supply-chain infrastructure following the pandemic and increasing geoeconomic fragmentation.

For example, the largest direct investment in infrastructure in 2022 was the takeover of Autostrade per l’Italia (ASPI), one of the largest toll road operators in Europe, by a consortium of investors led by CDP Equity, Italy’s sovereign wealth fund, Blackstone Infrastructure Partners, and Macquarie Asset Management. The consortium purchased a 88% stake in the company from Atlantia, an Italian infrastructure group, in a deal reported to be in the realms of €8.1 billion. The company had faced financial troubles and controversy after a deadly bridge collapse in 2018. In 2022, Mario Draghi’s government decided to take a direct stake in ASPI, which manages over 3,000 km of highways in Italy, through CDP Equity. The move aimed to improve the safety and management of Italy's roads and support the country's economic recovery by boosting investment in infrastructure.

Source: IFSWF Database, 2022.

Investing For Current and Future Generations

Assets such as roads, bridges, airports, and ports are critical for economic growth and social development, and their development can create significant positive externalities. As such, investing in infrastructure can have a positive impact on the communities served by these assets, which may align with the goals of sovereign wealth funds that prioritise long-term sustainable development. Infrastructure investment can also provide benefits beyond financial returns. As highlighted in last year’s Annual Review, two IFSWF members have a specific mandate to attract foreign direct investment into infrastructure assets: India’s National Investment and Infrastructure Fund (NIIF) and the Indonesia Investment Authority (INA). As of 31 March 2022, NIIF had committed approximately $485 million to six funds ranging from green businesses, affordable and mid-income housing, and healthcare via its fund-of-funds strategy.

However, despite the economic and social benefits of infrastructure projects in developing countries, sovereign wealth funds favour developed markets. They invested over $15.3 billion in developed markets across 24 deals against only seven deals worth $2 billion in emerging markets. This bias reflects the bigger ticket sizes, the more mature regulatory frameworks and proven demand in developed markets, making them less risky than emerging-market projects. That said, sovereign wealth funds are increasingly interested in understanding new mechanisms for putting capital into emerging market infrastructure.

Financing the Energy Transition

Direct infrastructure investments often go hand-in-hand with sovereign wealth funds’ efforts to align with their country’s climate change policies, even if they are not solely development funds. For example, the Nigeria Sovereign Investment Authority (NSIA) announced an increase in financing for the assembly and deployment of 200,000 solar home systems to $24 million in January 2022. The investment was part of the “Solar Power Naija” partnership between NSIA and Nigeria’s Rural Electrification Agency (REA). This project aligned with the local administration’s economic sustainability plan under the supervision of Nigerian Vice President Yemi Osinbajo.

However, in 2022, sovereign wealth fund direct investments in renewable energy declined to $2 billion across nine transactions from $5 billion in 13 deals in 2021. That said, the environment for these types of projects may be becoming more favourable in the coming years following the passing of the US Inflation Reduction Act, which includes approximately $369 billion in incentives for clean energy and climate-related spending, including funding to encourage carbon capture, utilisation, and storage (CCUS) projects and the imminent EU Net-Zero Industry Act, which aims to stimulate investment in renewable energy projects in Europe. These stimulus programmes are likely to increase the attractiveness of developed market renewable energy opportunities to the detriment of emerging and frontier economies, whose economic growth is more correlated with carbon dioxide emissions.

That said, direct investments in renewable projects are only one – if sizable – route that sovereign wealth funds are pursuing to tap into climate-change opportunities. Sovereign wealth funds are also creating investment partnerships and platforms with asset managers or other strategic partners.³ For example, in June 2022, Temasek launched GenZero, an investment platform to accelerate decarbonisation. The Singaporean investor committed an initial amount of S$5 billion ($3.6 billion) to establish GenZero to invest globally across three areas: technology-based solutions, nature-based solutions, and carbon ecosystem enablers.

In 2022, the total invested across renewable energy, carbon capture, agritech, new materials and forestry was $6.6 billion, slightly lower than $7.2 billion in 2021 across 52 transactions versus 54 the year before.

Source: IFSWF Database, 2022.

Challenges and Opportunities

While the shift towards direct infrastructure investments offers opportunities for sovereign funds to achieve attractive risk-adjusted returns, they must also consider the challenges. One fundamental obstacle for sovereign wealth funds is the need for specialised expertise in infrastructure investing, including identifying attractive investment opportunities, conducting due diligence, and managing assets effectively.

Another challenge is the potential for political and regulatory risks, particularly in emerging markets where infrastructure investments may be subject to greater uncertainty and volatility. However, with these challenges come opportunities for sovereign wealth funds to develop new capabilities and partnerships to help them navigate these risks and achieve long-term success in the infrastructure sector. “What’s very important for us when we invest with partners is alignment because ultimately, we’re not involved in the management of these investments”, says Karim Mourad, global head of the infrastructure department for the Abu Dhabi Investment Authority (ADIA). “It’s really important that we pick high-quality partners.”