Speaker 1Hi, I'm Bruno Alves, and welcome to the Infrastructure Investor Podcast. In today's episode, I sit down with Petra Nikolova, Deputy CIO and Head of Infrastructure at the Office of the New York City Controllers Bureau of Asset Management. The Bureau oversees the investments of the five New York City retirement systems, which have a collective $280 billion of assets under management, of which $8.4 billion are invested in infrastructure. Petra has led the infrastructure program since inception, and has now had the opportunity to see it perform in a high-inflation environment. That forms part of our discussion, alongside infrastructure's role as a diversifier in the system's portfolios, how to thoughtfully manage exposure to the megatrends of digital infrastructure and the energy transition, and also whether infrastructure as an asset class is climbing up the risk curve. Hi, Petra, welcome to the podcast.
Speaker 2Hi, Bruno. Thank you for having me. It's a pleasure to be here.
Speaker 1So, you're actually the first LP that we are having on the Infrastructure Investor Podcast. And maybe my first question could be a little bit broad, and you could just tell our listeners, what do you want your infrastructure portfolio to do in the context of the pension funds that you manage, you know, versus your other asset classes?
Speaker 2Absolutely. So, the way. We structured the infrastructure, and the reason why it exists, if you will, is that we wanted to provide inflation linkage. We want the asset class to provide diversification. And we also look at the asset protection, and the way we think about it also is superior. We would like to think we generate that risk-adjusted returns.
Speaker 1So, a few things to pick up on there. Inflation, you know, has become. It's obviously been under the spotlight, and then infrastructure is inflation. We've been using capabilities along with it. We now have performance data from an inflationary period. So, how did infrastructure actually perform for you?
Speaker 2I must say that I was very excited, in a way, to go through that period, because we haven't been as an asset class through high inflation period. So, with that, to your point, there are more observations, more research, more data points that prove that the asset class actually works in that inflation linkage. So, in our portfolio, we have seen the inflation pass through the different revenue models. So, we've seen that pass through, say, strong market positions or contracted structures or regulated, also, assets. So, we've seen that. And also, there is more research now. You can see, for example, that during the 2022-2023 period, infrastructure as an asset class, this includes. All strategies is generating around 9%, whereas other asset classes on the private side are generating either low single digits or even negative returns. So, this shows you how well infrastructure withstood that period. Well, we're still in that period, but for 2022-2023.
Speaker 1Okay. Is it fair to say, then, it's got the strongest inflation pass-through capabilities, you know, across private asset classes? Or how would you class that in those terms?
Speaker 2I would agree with that. That's what we have seen in our portfolio. And some research has also pointed to that. Of course, we are not out of it. I think what we're seeing right now is continuation of that environment. So, the test continues. But so far, the results have been strong.
Speaker 1And you also mentioned diversification. And I'm thinking, you know, given the way public markets are shrinking, and, again, infrastructure is not the only other private asset class offering diversification benefits, how would you assess the diversification you get from infrastructure?
Speaker 2And that's a great point because the public market's high shrinking, and also it's becoming more concentrated, to add to your point. So, the private asset classes are adding more diversification as well. And to answer your question directly about infrastructure, how is. How is that different? Of course, there are different correlation matrices, and we see all that. And that looks very good for infrastructure. But even as we think about the deal flow that we see, for example, energy transition, that falls primarily in infrastructure. I mean, you can see some of it in private equity, some of it like buyouts or venture. But that theme that has such a huge need in the trillions for investments that I believe is going to be primarily infrastructure, or digital infrastructure, which plays on the AI trend. And, again, you can see that in private equity to a certain extent, but a lot of it is going to be infrastructure. And, of course, you have downside protection in infrastructure that you don't really see in the same way in other asset classes.
Speaker 1Yeah. And I'm very keen to get into those two sectors actually very, very soon. I just have just a couple of questions I wanted to, just to get a sense of how you're allocating to infrastructure. Yeah. I just have just a couple of questions I wanted to, just to get a sense of how you're allocating to infrastructure, and the pacing of it. So I think when we caught up with you last year, the five schemes that you managed, their infra allocations stood more or less between 4% and 5%. I'm just wanting to get a sense of growth and how you envisage growth for those allocations.
Speaker 2So as you pointed out, Bruno, this was relatively recent. So last year when we spoke, we had a new, at that time, new allocation to infrastructure that took us to these levels. And for background, a few years prior to that, we had a new allocation to infrastructure that took us to these levels. Our allocations pretty much doubled. So what this means is that we still have room to grow within the current allocation. So we'll see where we are. We are hoping over the next few years to be fully deployed. So that, to your question, saying the next strategic asset allocation, that allocation increases. But right now we have enough room and our main goal would be to continue delivering very strong results. So that there is a solid reason for the allocation to be increased.
Speaker 1Sure. No, that makes sense. And just on pacing, I mean, what we've been hearing a bit or we heard a bit over 2024 is that the denominator effect wasn't so much the issue last year, but lack of distributions was a problem. And so I wanted to know, how is it for the schemes you manage? And have you been able to maintain the pace of investing that you wanted to or you hit some of these roadblocks?
Speaker 2Due to these dynamics. Yeah, I mean, I think one of the things that we just discussed and the fact that our allocation was increased quite a bit over the last few years, we continue to deploy evenly over a period of time so that we can achieve vintage diversification. Therefore, we haven't downsized our investments per year and we continue to actively deploy in the market. So we are active. We continue doing deals. And I'm also happy to share that. We actually have seen some strong exits. So it's an active market.
Speaker 1So now keen to discuss how the asset class has been evolving. And you've mentioned energy transition and digital. And, you know, one of the things that resonated with us and I know a few other people in the market when we interviewed you last year, you mentioned that you really wanted to see an energy transition fund that is clearly infrastructure. And so kind of a year later, I'm just wondering, how are you feeling about that now? And are things any clearer?
Speaker 2So the market continues to evolve. We continue having discussions with various groups that are focused on energy transition. And what the change has been is that there is much more focus, I would say, on what the mandate for the fund is, what are the subsectors that are targeted and equally importantly, what are the ones that are not targeted by this particular strategy? And the other aspect of it is, I would say, much more focused on articulating the infrastructure characteristics of the strategy and downside protection, right? Because this is really key for infrastructure. And some of these parameters were not that clear last year, and I would say, to me anyway, and this year they're becoming more clear. I would say, however, that we are seeing this. We are seeing this segmentation where you have the renewables and these funds have been there for a while that target renewables. There are funds that are targeting renewables and some of the newer themes in energy transition. And now we are seeing also more firmly energy transition funds focused on the newer themes in energy transition. And that I think it's very positive because it goes to what is the risk and how LPs expand. They expect to be compensated for the risk they're taking. So as you have these differentiation, this becomes clearer. I think of them as, you know, like growth infrastructure. So to your question, like, is this clearly infrastructure? It's I think these particular energy transition funds, they would be probably on the higher spectrum of risk, but also with a higher return expectation.
Speaker 1Yeah. No, I think that's totally fair because some of the scale up risk that some of these funds introduce. Yeah. And that's what I also wanted to just check with you. So you're kind of seeing that scale up risk, it puts you at the higher end of the infraspectrum. But I guess you're seeing enough of the downside protection and enough of the traditional characteristics to be comfortable and not just, you know, something that goes outside of the infraspace or doesn't do the basics, right? It's higher risk, but it's still doing some of what you want out of the asset class, I guess.
Speaker 2That's exactly right. And you can have a conversation around exactly what the downside is, right? Deal by deal, depending on what the strategy is, what other risks are being taken. And again, these are, I would say, totally approached and hopefully they will be mitigated. We don't have a lot of track record there, right? So it's a little bit also where infrastructures and asset class was a few years ago, less track record. So now this particular space, I think is at that stage.
Speaker 1Yeah, I think that's a really good point. And then we have sort of these new AI infrastructure strategies, very data center heavy, but mixing digital infra and power. And I think that kind of further clouds a little bit, the risk return spectrum. And so I'm curious how you are viewing that, you know, those strategies, but also the way digital infra is evolving because power is becoming a big part of it also. And again, sort of how you see that fitting into what you want out of your infrastructure bucket.
Speaker 2That's a great point. We had been observing this convergence, if you will, of the AI trend and then the power because of what you just outlined. And I think that convergence is going to become more prominent. We've seen the expectations for increase in power demand in the US that hasn't been the case for many, many decades now. But I think the way we view it is we go back to the fundamentals of infrastructure, right? And ask ourselves, what risks are we taking, right? Very similar to the discussion on energy, transition. How is the downside protected? For example, we talk about the data centers, right? Is the land there? Is the power there? If not yet, how is this going to be secured, right? So you could have the structural protections of the asset class. And for the hyperscalers, what we've seen is multi-decades, potentially contracts. So I think that it would depend also on how these deals are structured. As I said, I'm not an expert, but I think it would depend also on how these deals are structured. As I said, I'm not an expert, but I think it would depend also on how these deals are
Speaker 1and how these deals are Do you think, in a sense, do you feel that the asset class's risk return spectrum is sort of slowly being pushed up? Obviously, you have core offerings. They're still out there in the market. But sometimes there is a sense that maybe, yes, that the asset class is moving up the risk curve, as it were.
Speaker 2I think it's more about changing needs in our society than the asset class necessarily moving up the curve. Because different strategies can be at different points in that curve. But as we think about data centers, they didn't exist to the extent they exist today or will exist tomorrow. Because when was ChartGPG adopted broadly? It was just a few years ago. It's amazing to think that it was so recent. So I think that we see rapid changes that necessitate rapid change in infrastructure. So I don't necessarily think. I don't necessarily think that the asset class is moving in a direction that it shouldn't be moving. Say, it's becoming more technology-based and driven. Although, of course, the drivers are there. But in terms of the structure, you can still have less risky strategy or core, more structured and mitigated risks. And to your point, higher risk spectrum, more speculative, more development. So, again, as an asset class, I don't necessarily think. It's moving as an asset class to the higher end.
Speaker 1Yeah. No, and that's a really good point about changing needs and catering to that. But let me ask you about how your portfolio is shaping up or how other portfolios can shape up. Because it obviously seems, you know, nowadays that everybody is doing this, doing energy transition, doing digital, generalists, specialists, everybody. And so are you concerned a bit about concentration risk or, you know, how your portfolio might become? Too exposed? And if so, how do you try and mitigate that?
Speaker 2Yes, you're absolutely right. We are monitoring this very carefully, these dynamics. And we have historically been pulling between 20 and 25 percent energy transition over the years. But digital was really the asset class that increased very, very quickly in our exposure. And the other dynamic there is that. And valuations are also increasing because data centers are so much in demand. So you have more assets in that bucket, the digital, but also valuations increasing more quickly. So to your point, exposure is increasing quite a bit. So how do we mitigate that? What we do is we spend a lot of time understanding what the fund that we want to invest in potentially would in turn invest in. And, of course, guidelines. The guidelines are broad, but what is truly the target portfolio? And, of course, these are investment periods of three to five years. Of course, these are blind pools. But we really try to understand the thesis at the time that we invest. Importantly, we have had longstanding preference for diversified funds. Why? Not only because it gives us more diversification. But. It protects us as the world changes and you have different drivers in different geographies and different sectors. So we have generally preferred diversified funds, which means that we haven't invested in a digital specialty fund or anti-transition specialty fund. But yet we have a lot of exposure. And one of the reasons not being best is also the concern that this may get too high. And finally, we also don't want. We want to not take advantage of good opportunities in these sectors if we see such opportunities. So we have a co-investment program and there we can see specific deals. We can not a blind pool. Right. So this is how we approached it. Yes, we are concerned about exposure, but at the same time, we don't want to miss on opportunities that we think are going to be a great addition to the portfolio. So we. Analyze this specifically. And that's how we add. In fact, we added last year a platform, a new levels. So energy transition, if you will, although all those things and that's how we approach that.
Speaker 1OK, so I have a couple of last topics I wanted to cover with you. This one also is a follow up to something you mentioned last year in our interview. You had mentioned that you wanted to increase commitments in 2024 to mid market funds. So first question wanted to ask. How that when and if when successfully or as you expected. But also, what are you seeing in mid market funds that you're not getting elsewhere?
Speaker 2So we did invest in mid market last year and we also invested in some of our longer standing partners that happen to be now larger. So we have invested in different parts of the market, if you will. And going back to the point of diversification, that is a very important point. For us, for the middle market, because you can get assets that are just smaller and have different drivers that some of the large assets that other parts of the portfolio can deliver for us. You can also have different strategies like platform creation, et cetera, for the middle market that are probably a little bit harder when you become a certain size. And finally, also the exit routes are probably different to a certain extent. So as we think about middle market, that's what we see and why we want it in our portfolio. And I just want to make the point that from a return point of view, we expect great returns, both from our mid market, from our large cap, from all the managers in our portfolio. And that's why we partner with them.
Speaker 1Yeah, yeah, yeah. No, I understand. So it's not so much a matter of going to the middle market for outperformance or something of that sort. Yeah. Just different needs, I guess.
Speaker 2Yes. And we go with who do we believe the best manager is and that they will deliver the returns that they have targeted.
Speaker 1Yeah. And one last question. You've been an LP in funds managed by the likes of Global Infrastructure Partners, BlackRock, Actis, DIF. All of them have been through, you know, this wave of consolidation in one way or other that is sweeping the industry. So, you know, how, as an LP in many of these funds, how are you experiencing this? What is your take on all of this consolidation that we saw in 2024 and in previous years?
Speaker 2So you're right. I mean, it's not new. We've seen consolidation before. It has been in infrastructure. It has been in private credit, a lot of it. And. I think we are going to see even more. The market conditions are difficult. That's one. Number two, platforms are trying to grow and become more multi-asset. And infrastructure, to just focus on infrastructure here as opposed to the other private, brings, as we discussed, different characteristics. So if you have a private equity platform that is oriented to growth, you can add an information manager that can add more income, different risk return profile, inflation linkage, as we discussed in the beginning. So it's a different set of attributes that can be complementary to the other product offerings. And of course, you have the public companies that are trying to either expand or enter the private market space. And we talked about that as well. So I think that that trend will continue. And my view hasn't changed on how this would impact the firms that have been part of that trend. I think that there are going to be synergies in some places. So there is positive and there could be complementary products. And then there are questions, right? How the culture work and how would the strategies change potentially? But I think it's like probably a little bit early to assess. Assess the exact impact on the different strategies and players.
Speaker 1Yeah. No, I think that's fair. And also, you know, a good note to end on. Petra, thanks so much for coming on the podcast. And it was great to see you again.
Speaker 2Thank you so much, Bruno.
Speaker 1That, again, was Petra Nikolova, Deputy CIO and Head of Infrastructure at the Office of the New York City Controllers Bureau of Asset Management. To hear more of our episodes, head over to the website at www.newyorkcitycontrollers.com. You can also head over to www.infrastructureinvestor.com forward slash podcast, or you can search and subscribe to the Infrastructure Investor Podcast wherever you like to listen.
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