Infrastructure: A Potential Economic Shock Absorber

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Global political tensions are running high, and elevated interest rates have been a source of uncertainty for financial markets. Meanwhile, our Global Macro & Asset Allocation team believes that inflation will remain higher for longer and be more persistent. The team has noted that bonds are becoming less effective in their traditional role as economic shock absorbers as they move more in sync with stocks, even as inflation cools (Exhibit 1).

EXHIBIT 1: The Performance of Stocks and Bonds Is Highly Correlated

U.S. Stock-Bond Correlation and U.S. CPI, %

Chart showing U.S. Stock-Bond Correlation and year over year inflation.
Note: Stocks refers to the S&P 500 and Bonds refer to the 10-year Treasury Yield. Data as of September 30, 2023. Source: KKR Global Macro & Asset Allocation analysis

So, where can investors look for relatively steady investments amid economic volatility? As discussed in A New Foundation for Global Wealth, historical data show that private infrastructure investments have displayed less volatility than most other asset classes, while also producing attractive returns. The combination of those two factors has yielded compelling portfolio benefits relative to most other asset classes over the last 10 years (Exhibit 2).

EXHIBIT 2: Private Infrastructure Experienced Lower Volatility and Higher Risk-Adjusted Returns than Many Asset Classes over the Past 10 Years

Asset Class Annual Return and Standard Deviation: 2012-2022

Chart showing the average return and volatility across asset classes from 2012 through 2022.
Data as at 12/30/2022. Private Real Estate modeled using the Cambridge Associates Real Estate Index. Private Infrastructure modeled using the Cambridge Associates Infrastructure Index. Private Equity modeled by using the Cambridge Associates Private Equity Index. Private Credit modeled using the Cliffwater Direct Lending Index. Source: KKR GBR (Global Macro, Balance Sheet and Risk team). Return Per Unit of Risk is calculated by taking the total return divide by the standard deviation of that today return.

In fact, reallocating just 10% of the equity portion of a traditional 60/40 portfolio to private infrastructure investments over the past 10 years would have resulted in lower volatility and higher risk-adjusted returns, without sacrificing overall excess returns (Exhibit 3). There is no guarantee that this trend will hold over the next 10 years; however, we think the very nature of infrastructure investments support their role in a portfolio as a volatility dampener.

EXHIBIT 3: Replacing 10% of the Equity Allocation in a 60/40 Portfolio with Private Infrastructure 

A comparison of excess return and volatility of a traditional 60/40 portfolio compared to a portfolio that is comprised of 50% global equities, 40% global bonds and 10% global private infrastructure.
Source: There can be no assurance that the trends described herein will continue or benefit the Fund. Returns for the Private Infrastructure Equity Index proxied using the Burgiss Global Private Infrastructure Index, Global Equities are proxied by the MSCI AC World Index, and Global Bonds proxied by the Bloomberg Global Aggregate Index. Excess returns calculated over the ICE BofA 0-3 Month US Treasury Index returns. Results calculated using quarterly returns from 12/31/2011 to 12/31/2022. Source: Burgiss, MSCI, Bloomberg, KKR Portfolio Construction

Why Does Infrastructure Act as an Economic Shock Absorber?

We think there are two main reasons that infrastructure tends to reduce volatility in a portfolio.

1. Critical Assets with Stable Demand: Infrastructure assets—such as power generation, water distribution, data centers, or fiber-to-the-home networks—offer essential services that are the bedrock of an economy and society. Demand for these services typically remains relatively stable, regardless of broader economic conditions.

Moreover, the substantial startup costs to develop renewable energy generation projects, mobile communications infrastructure, or waste management capacity create high barriers to entry for potential competitors. These barriers lead to stable market structures over time, which make the cash flow profiles of infrastructure assets more stable.

2. Predictable Cash Flows: Private infrastructure investments are typically tied to physical assets with stable long-term cash flows. Revenues are often based on long-term contracts, some of which span decades and often include protections against inflation through CPI-linked escalators. 

The resilience of infrastructure, stemming from the essential nature of infrastructure assets and high visibility into cash flows, was on full display in 2022, when interest rates climbed sharply and introduced new volatility across financial markets (Exhibit 4).

EXHIBIT 4: Essential Nature of Infrastructure Assets and Contracted Yields Provided a Cushion as Interest Rates Rose

Performance in 2022

A bar chart showing the performance of various asset classes including infrastructure, bonds, and equities, as interest rates rose in 2022.
Source: Global Private Infrastructure refers to the Cambridge Associates All Global Private Infrastructure Index. Non‐Inflation Government Bonds refers to the Bloomberg U.S. Treasury Total Return Unhedged Index in the US, the FTSE Eurozone Government Bond Index in the Eurozone, and the FTSE Japan Government Bond Index in Japan. Source: Cambridge, Bloomberg, KKR GBR analysis. No representation is made that the trends depicted or described above will continue.

Private Infrastructure in Practice

To understand infrastructure’s shock-absorber capabilities, consider a few practical examples – some with infrastructure-like characteristics, and some without. While these were chosen specifically to illustrate the durability of infrastructure business models, they highlight the key attributes that underpin our risk-based approach to infrastructure.

Infrastructure Investments

In our view, the digital revolution is a long-term mega-theme that will play out well beyond the next decade. Consumers, businesses, governments, and all kinds of organizations will generate more digital data, underpinning continued growth in demand for data storage and processing. The buildout of data centers necessary to support this incredible growth will likely require hundreds of billions of dollars of capital investment. These investments are typically backed by long-term fixed revenue contracts with strong, investment-grade customers. Even in a severe economic downturn, we would not expect existing data centers supporting cloud computing customers to experience cash flow volatility given the nature of these contracts.

Another consistent global trend has been the transition to a low-carbon economy and the subsequent shift to renewable energy. Renewable energy businesses with long-term contracts often have a cushion against economic downturns in that long-term power purchase agreements with utilities and large-scale corporate customers tend to have fixed prices.

Non-Infrastructure Investments

How do the infrastructure business models described above differ from other business models across the rest of the economy? Some media businesses are closely linked to the digitization trend, whether they provide streaming music or other kinds of content, that also encompasses data centers. However, many media businesses rely on revenue from two sources: subscriptions and advertising. Neither comes with long-term contracts. Subscribers can cancel easily, and advertising buys tend to occur on a short-term basis, with meaningful sensitivity to broad economic conditions and cycles. Media businesses may grow fast, but they also tend to attract heavy competition (given asset light business models and inherently lower entry barriers), and preferred formats, technologies, and providers may change quickly.

In Summary

What sets infrastructure apart as a cushion against volatility are its ties to crucial, physical assets with stable end-market demand and highly predictable cash flows. At a time of great economic and geopolitical change, we think it is important to keep in mind that infrastructure historically has experienced less volatility than many other asset classes, even during economic shocks like 2022, while also producing attractive returns.

  1. Infrastructure