Private markets: Our top picks for future-facing portfolios

The following is an extract from our recent publication: The future of private markets.

Energy transition infrastructure

Almost 90% of the world’s population lives in countries that have adopted net-zero targets[1]. In an indication of the scale of these efforts, the infrastructure required for Europe’s energy transition alone offers an €840 billion opportunity for investors[2].

We see strong potential in wind and solar farms, battery storage, and the upgrading of power networks to accommodate increased renewable capacity.

As decarbonisation accelerates, the infrastructure investment universe should expand and offer an increasingly diverse set of assets with varying risk/return characteristics for both debt and equity investors.

Certain assets may offer stable cash flows, predictable offtake agreements[3] and significant barriers to entry – offshore wind assets with long-term contract for difference arrangements, for example. Other assets like green hydrogen production facilities or carbon capture/storage may carry higher (perceived) technology risks and offer less certainty on offtake prices.

We think the diversification benefits of infrastructure portfolios will grow as new risk factors are added and the investible universe expands.

Equally, we see a growing role for ‘natural capital’ alongside other real assets in support of both financial and non-financial investor objectives. This involves nature-based climate solutions that seek to reduce greenhouse gas emissions or sequester carbon dioxide from the atmosphere, in the process generating verified carbon credits that can aid investors with net-zero targets in their emission reduction pathways.

Residential

An increasingly volatile macroeconomic and geopolitical environment could support more needs-based, counter-cyclical, inflation-hedging assets. Over a long-term basis, residential rents have outstripped inflation across many key markets, while at the same time exhibiting lower volatility than other commercial property sectors, as illustrated on the right.

We believe the combination of ongoing urbanisation, population growth and shortages of residential supply will continue to support new asset creation and comparatively stable rental growth over the long term.

We see continued debt and equity investment opportunities for multi- and single-family residential, including affordable housing, and we anticipate purpose-built student accommodation for top-tier universities could deliver healthy rental growth and accretive risk-adjusted returns against the right backdrop.

Industrial and urban logistics

E-commerce and social media have driven a radical shift in shopping behaviours. The need for traditional bricks-and-mortar shops has declined and demand for logistics facilities and multi-let industrial estates has burgeoned as retail undergoes its digital transition. At the same time, with globalisation slowing, we see future potential benefits emerging from selective onshoring in nationally critical industries and greater demand for higher inventory capacities.

This growth in industrial real estate portfolios is not new. Over the past 20 years, the industrial sector has grown from 16% to 32% of real estate portfolios in the UK by value[4], and from 23% to 39% in the US[5].

The strength of the structural forces underpinning the sector means we expect it to retain its dominant role in real estate portfolios, with significant scope for expansion among higher-growth sub-sectors like cold storage[6] and self-storage.

We think cold storage represents a particularly compelling emerging growth opportunity. Demographic factors like population growth, the increase in single-person households, urbanisation and the prevalence of households with two working members have led to strong growth in both online grocery shopping and convenience store networks, contributing to increasing demand for efficient cold chain logistics. According to JLL, the sector enjoys higher rents, occupancy, and lease lengths than other industrial assets[7], with Green Street forecasting stronger returns for the sector in the US than the All Property average[8].

Digital and high tech

The advent of generative AI has only added to the already vast demand for computing power and data storage to support the digital revolution. In our view, this next generation of digitalisation will require a rapid increase in data processing and storage facilities (i.e. data centres) and substantial additions to digital infrastructure networks (5G, mobile and fibre networks etc). We think this could increase the attractiveness and volume of investment opportunities in these sectors.

While data centres’ environmental impacts need to be reduced over time and rapidly changing specifications require investor attention, we expect demand for data storage and processing to grow exponentially. We anticipate that it will be challenging for supply to keep pace with this growing demand, with power and planning constraints already restricting data centre development in certain key locations, with Frankfurt in particular struggling to deliver the infrastructure it needs. Combined with restrictions around new supply, in our view increased space demands are likely to create favourable supply and demand dynamics and support rental growth.

We also believe life science companies are well placed to benefit from several key markets’ ageing populations, their increasing emphasis on personalised medicine, and their global healthcare spend, with continued venture capital funding playing a key role. We see investment opportunities across the risk-return spectrum, incorporating lending to high-quality credits, core and value add real estate equity assets, and direct investment in early growth stage companies. The trend towards companies staying private for longer means that private equity exposure is an increasingly critical component of accessing the huge growth opportunities available through early stage digital and tech businesses. Market expertise, relationships and the targeting of specific geographic clusters is key to accessing the sector at scale.

Perhaps counterintuitively, an increasingly digital world may add a premium to creativity, idea generation and human interaction. As we can see from the chart below, leisure has grown as a proportion of consumer spending over the past decade, despite the concurrent explosion in digital connectivity. We see this as reflecting the continued value of social spaces in a digital world and continue to see a role for hospitality investments within future-facing portfolios.

The above is an extract from our recent publication: The future of private markets.

[1] Source: Net Zero Stocktake 2023; NewClimate Institute, Oxford Net Zero, Energy and Climate Intelligence Unit and Data-Driven EnviroLab

[2] Source: https://www.lgim.com/lu/en/responsible-investing/clean-power/

[3] An offtake agreement is an arrangement between a producer and a buyer to purchase or sell portions of the producer's upcoming goods. It is normally negotiated before construction to secure a market and revenue stream for its future output.

[4] Source: MSCI UK Quarterly Index: Q4 2003 versus Q3 2023

[5] Source: MSCI UK Quarterly Index: Q4 2003 versus Q3 2023

[6] Source: Cold storage is a facility that primarily stores food items that are short-lived and highly likely to get spoilt under normal conditions (e.g. fruits, vegetables, fish, meat etc.)

[7] Source: JLL, Cold storage: a real estate perspective

[8] Source: Green Street Global Property Allocator, January 2024