2025 infrastructure outlook: Bridging the valuation gap

Key takeaways

• Infrastructure’s differentiated returns could offer some diversification away from the risks of concentrated trades, and with President-elect Donald Trump’s policies potentially leading to a second round of inflation, infrastructure’s inflation pass-through mechanism could be even more attractive in 2025.
• Peaking interest rates are a good sign for infrastructure, as we have seen it outperform global equities following the last Federal Reserve (Fed) interest-rate hike prior to cutting cycles. At the same time, we believe we’re still seeing a catch-up of a gap between infrastructure earnings and total returns since 2022, and valuations are attractive for this reason.
• Opportunities remain widespread across the infrastructure landscape, with utility fundamentals some of the best we have ever seen and the market still massively underestimating the growth in electricity demand driven by artificial intelligence (AI) and data growth.

Defensive and diversifying returns valuable in 2025

The concentrated market of 2024 and the return of inflationary pressures are a good reminder of what sets infrastructure apart from other asset classes and why we believe this will be attractive in 2025. First, infrastructure offers a differentiated source of returns; unlike general equities and real estate, the key driver of long-term returns for infrastructure investors is growth in the underlying asset bases. Regulators generally provide an allowed return with reference to the underlying asset base of these essential companies, though how this occurs varies by region. If the regulator is providing steady allowed returns on a growing asset base, we would expect earnings to increase at broadly the same pace as the underlying asset growth.

Second, infrastructure offers inflation protection. Infrastructure assets are designed to provide long-term benefit for their communities and stakeholders and, as a result, allowed returns are generally linked to inflation. This inflation “pass-through” mechanism allows prices paid by the users of the asset to adjust periodically and ensures that the returns to equity investors funding these assets are not eroded over time due to the effects of inflation. Importantly, this inflation pass-through can take anywhere from three months to three years to have an impact on reported earnings, depending on the type and location of the assets.

With early 2024 returns for most investors dominated by momentum related to the Magnificent Seven stocks,¹ or more recently cyclical stocks surrounding the US presidential election, infrastructure’s differentiated returns offer some potential diversification away from the risks of concentrated trades. And with Trump’s policies potentially leading to a second round of inflation, infrastructure’s inflation pass-through mechanism will likely be all the more valuable in 2025.

Total returns still catching up to strong earnings

Peaking interest rates are a good sign for infrastructure, as we have seen it outperform global equities following the last Fed rate hike prior to cutting cycles (Exhibit 1). After central banks kicked off easing in late 2023, market breadth has continued to improve. As this has occurred the market has begun to recognize the strong fundamentals and secular themes of the infrastructure asset class. These include decarbonization, growing power demand from AI and data growth, and significant network investments to replace aging assets, improve resiliency and meet the needs of realigning supply chains and onshoring trends.

For utilities, we think their earnings stability will be sought after in what looks to be a more unpredictable and volatile market going forward. Add to this the structural tailwinds we are seeing in AI, decarbonization and network investment, and utility asset bases and earnings are set to grow at some of the fastest levels we have seen in many years.

User-pays infrastructure assets are more tied to gross domestic product (GDP) growth, which is projected to stay at 3.1% globally in 2024 and rise to 3.2% in 2025,² per the International Monetary Fund (IMF) report. This bodes well for economically sensitive assets such as toll roads, airports and ports. Freight rail in the United States should also see increasing momentum, as the US economy continues to be a standout grower among its peers. The risk remains, meanwhile, that reflation could hinder some of the consumer-driven services such as travel at the margin.

Zooming out, we believe we’re still seeing a catch-up of a gap between infrastructure earnings and total returns which has been in place since 2022, and valuations are attractive for this reason. Even though there has been a strong positive correlation between infrastructure earnings growth and infrastructure total returns, increasing earnings and strong fundamentals have yet to fully offset the dislocation in valuations due to the rise in real bond yields in 2023 (Exhibit 2). We expect this gap to close over time as the market recognizes the strong long-term themes of infrastructure.