Perhaps one of the biggest developments in private markets’ relatively short life span is the emergence of infrastructure as a stand-alone investable asset class. In only 20 years, the capital raised in support of infrastructure private markets has risen dramatically. Its attributes of inflation protection, stable cash yield, defensive growth, and low correlation with other asset classes bring significant benefits to portfolios in all economic environments, especially during periods of high inflation.
When it comes to infrastructure investing, we tend to think of deploying big pools of capital into massive works of civil engineering. And while this can be true, it is not the rule. The fact is, smaller GPs have accounted for most of the funds raised since 2010—more than 8 out of every 10.
We define these smaller funds as the Middle Market, and while no standard definition exists, some investors have begun to consider infrastructure funds reaching as high as US$8 billion as Middle Market—which would have been unthinkable even two years ago. In private equity, our firm historically defined the upper range of Middle Market as funds up to US$3 billion in size. However, as the average market cap of target companies has increased and the number of publicly listed companies has decreased, fund sizes have grown. As a result our private equity team now considers funds as large as US$7 billion to be Middle Market.
Owing to these same dynamics, infrastructure has seen an increase in the average fund and deal size. This paper focuses on the lower end of that range (according to our older definition). That said, we believe the opportunity set in infrastructure has similarly increased over time.
Historically, as seen in Figure 1 and Figure 2, funds raising US$3 billion and below in infrastructure have seen a significant amount of activity:
- On average, 85% of funds raised during 2020–2022 had a fund target of less than US$3 billion; and
- On average, 49% of aggregate capital raised during 2020–2022 came from small- and mid-market funds.
The rise of infrastructure’s Middle Market is a function of the growth of investment opportunity at this fund size. As the asset class has matured, a handful of dominant and growing large-cap GPs have accounted for a large proportion of total fundraising. These same managers were raising fund sizes considered Middle Market a decade ago, when there weren’t any larger private capital pools, so the universe of deals they could access was different from today’s mid-market opportunity. Their move to larger transactions has left a void, which newer managers have filled.
Whereas large-cap managers tend to deploy billions into marquee assets and take-private transactions, mid-market GPs tend to be more specialized in standing up new platforms or “buying and building,” adding potential exit multiple expansion for a scale premium as modest-size platforms grow. On exit, a smaller fund can sell to a larger fund or a strategic buyer, whereas large asset positions in larger funds may have more limited liquidity options.
Other advantages include:
- Enhanced partnership—Mid-market GPs allow the possibility of greater investor influence, including fund documents, management fee discounts, GP stakes or the ability to affect fund strategy to meet an investor’s program objectives.
- Differentiated strategies—Mid-market deals provide access to parts of the market that are inaccessible to larger peers, such as platform build-outs, roll-up or aggregation strategies that cannot be done at a scale large enough for the large infrastructure funds.
- Specialists—There are more specialist GPs, which offer the ability to rely on superior industry-specific expertise and sourcing networks. In infrastructure, there are many telecom, greenfield and energy-transition specialists to consider.
- Co-invest opportunities—Mid-market GPs offer their LPs greater access to co-invest as they typically avoid programmatic co-invest terms. Many GPs offer co-investment opportunities associated with their fundraise, allowing for reduced blind-pool risk with new fund commitments.
Although there are many benefits to investing in infrastructure’s Middle Market, doing so has its challenges. For starters, the opportunity set is significantly larger, with many more GPs to consider than the large-cap universe. Many LPs lack the time and resources needed to research and review the myriad of generalists and specialists, or the time needed to conduct diligence on the growing universe of emerging managers. Active participation in the less trafficked Middle Market, however, brings the potential for outsize returns from top-tier managers, along with a portfolio “edge” created by sector and strategy diversification and potential for greater alignment and access to smaller GPs.
By working with a global partner that possesses a large and active sourcing engine and a team dedicated to the infrastructure market, LPs can receive assistance in assessing opportunities and can mitigate some of these challenges.
