Small can be beautiful too

The mid-market space offers an attractive risk-reward equation – and managers have learned lessons from turbulent times, says Arjun Infrastructure’s Serkan Bahçeci

The utilities, renewables assets, transport companies and data centres held by mid-market infrastructure funds may lack glamour compared with the trophy assets wielded by the mega-funds.

However, Serkan Bahçeci, head of infrastructure research at Arjun Infrastructure Partners, argues that the mid-market offers superior opportunities to acquire assets that can perfectly deliver a core risk profile through macroeconomic shocks, while allowing core-plus returns through amply available growth initiatives.

He adds that mid-market infrastructure has generally performed well during the recent period of macroeconomic volatility, but notes that adding protections against such unexpected events should be a core focus for managers.

Q How do you define mid-market infrastructure?

Everyone uses different numbers. The way we see it is that the mid-market is where auctions do not take place. As for the numbers, they increase all the time. These days we’re seeing assets with equity value of up to around the €500 million-€700 million range, or enterprise values below the €1.5 billion mark. That’s how we would define the mid-market.

Q Are you seeing more appetite from LPs towards mid-market infrastructure?

Most LPs already have exposure to multi-billion infrastructure deals through the mega-funds. And the mega-funds themselves will not make the effort to chase $200 million or $300 million equity tickets. So, for LPs, one simple step is to diversify away from the infrastructure mega-funds.

Mid-market deals don’t make headlines. They’re at the more boring end of the infrastructure spectrum, compared with those trophy assets. But acquiring trophy assets is often not that effective from a financial perspective, because you have to pay to get the bragging rights. That doesn’t really exist in the mid-market, as companies and assets at the smaller end are largely unknown. They operate in the background yet provide essential services – and that’s what leads to financial performance.

Although there a lot of managers in the mid-market, there are also a lot of opportunities. More than 90 percent of the transaction volume is in the small to mid-market range. One good example is when founders develop infrastructure companies to a certain size. Then when they’re at the brink of becoming a mid-market company, managers like ourselves will come in and help improve their management teams and processes, as well as financial approach to take the company to the next level. And hopefully to the largecap category through time.

Q There’s often a perception that smaller businesses tend to be riskier. How much is this reflected in the infrastructure space?

It’s true that common opinion in the listed markets, and even parts of the private markets, is that smaller businesses are riskier. And if you want to lower the risk, you move towards large-cap in the listed equities. But it doesn’t work like that in the infrastructure space – because our asset class is special.

We rely on long-term contracts, regulatory decisions on tariffs, very stable demand profiles and the monopolistic positions of assets. For example, you could have a regulated electric utility serving a small city somewhere in Europe, as a natural monopoly. If the manager is doing its job properly, and if the debt isn’t aggressive, that’s quite a safe investment. This is how we differentiate infrastructure from the other asset classes. The risk profile doesn’t rely on the asset size.

Q Is that well understood by LPs?

It needs to be explained. But of course, there are many very well-informed LPs that fully understand the various risk dimensions. But sometimes it has to be explained that mid-market doesn’t necessarily mean taking on more risk. A core or core-plus approach can easily be implemented in the mid-market infrastructure space. A mid-market strategy doesn’t need to have a private equity-like value-add or opportunistic risk profile.

“A mid-market strategy doesn’t need to have a private equity-like value-add or opportunistic risk profile”

Q What do managers need to do to ensure they can provide diversification?

Diversification is ultimately an LP decision. Managers offer funds and co-investments, but LPs need to look at their portfolios and their exposure to risks. They then need to pick products in the market that help them diversify.

As managers, if we want to give good diversification options, we should have some scepticism about the subsectors that are dominating transaction activity – namely digital infrastructure and renewables. Yes, a data centre can be a good investment, especially if it benefits from long-term contracts. But does it really offer a diversification benefit from a total portfolio perspective? If a portfolio has a lot of tech stocks, then when something goes wrong in that space, the data centre isn’t going to provide much of a diversification benefit.

It’s a similar story with renewables. To be clear, there are very good opportunities in those sectors, and managers are right to invest in them. But it’s also our job to diversify across underlying risk metrics that also affect other asset classes.

Q The industry has been through a turbulent few years. What are some of the key lessons that mid-market infrastructure managers learned from this period?

In early 2020, just before covid-19, I wrote a note to our investors, looking ahead to a new decade for infrastructure with the usual description of stability. Within a month, the pandemic started and transportation volumes collapsed. Then there was the war in Ukraine, energy prices skyrocketed and rapid inflation took place for the first time in our lives, followed by rising interest rates, again for the first time in our lives. We’ve had quite a turbulent five years, with one macroeconomic shock after another.

I call this period our first test as an asset class. Infrastructure passed the test with flying colours, but there are of course lessons to be learned. A big one is on the inflation side. Up until quite recently, all our discussion on inflation was purely theoretical, because inflation hadn’t been a serious problem for decades.

Now we know that just looking at revenues isn’t enough. It’s easy to tell the story that infrastructure cashflow is indexed to inflation, directly or indirectly. But the cost side was not so well understood, and that starts with the cost of debt. If you don’t have a fixed rate in place, and if you don’t hedge, you’re exposing yourself to the capital markets.

Before 2022, for 40 years, every refinancing had been a success. Interest rates were declining steadily during the super-cycle. People thought they were really smart – but really they were only riding the wave. I can tell you that all refinancing assumptions that were made before 2022 failed, there were no exceptions. In many instances, that was quite costly.

The second lesson is about capital expenditures. Managers tend to understand and forecast operational expenditures very well. But capital expenditures are a bit different. They’re usually large and they come with deadlines. That means if you start a construction project and inflation jumps, your costs will increase almost overnight, but your revenues will increase only gradually.

For example, solar panel prices had been declining for 15 years, but suddenly increased by about 60 percent in 2023. If you needed to purchase panels to meet a deadline, your costs increased by far more than you could recover through just inflation indexation of the revenue.

Q How will this likely impact how managers think about taking on development risk?

As managers, we have to take on capital expenditure. There’s no escaping that fact. And capital expenditures are actually very helpful to add value and grow the business. But we do need to make sure that we don’t expose ourselves too much to shock events. Managers should hedge their bets as much as possible – that could mean pre-ordering materials or making sure that deadlines aren’t too restrictive. Then, if a shock does happen, managers have factored in some wriggle room.

Q Overall, how have the crisis years affected the reputation of mid-market infrastructure?

We learned such lessons, but infrastructure did really well in aggregate. That’s one of the reasons why today we’re seeing increased interest in infrastructure from LPs. People understand the role that it plays in a big portfolio – and that it can be a cornerstone providing stability. That’s why we’re seeing an increased level of investor appetite.

Likewise, LPs and GPs are both paying much more attention to cash yield. A manager can only give an estimate on asset values without an actual transaction, but cash yield is real. That’s what investors need in a crisis situation. Providing a stable yield that we keep promising as an asset class is essential. We’ve done that quite well, but cash yields have to be a constant focus that everyone should be looking at very carefully.

“We can safely say that we understand what the new world looks like with transportation – there’s much more certainty”

Q Beyond digital assets and renewables, which subsectors offer the best diversification opportunities?

Transportation was hit hard by covid-19, and for a few years not much happened in that space until last year. Now we can safely say that we understand what the new world looks like with transportation – there’s much more certainty around the working from home trend, as well as demand for business and leisure travel. Transportation is a sector that everyone’s thinking about again.

Another good opportunity is in regulated utilities. Utilities got a lot of bad press recently, especially in the UK. There have been inconsistent regulatory decisions, regulators focusing too narrowly on the end-user bills and not allowing the much-needed capital expenditures programmes, and a bunch of mistakes from the sponsors on the debt size.

That aside, regulated utilities will remain and are of course a vital form of infrastructure. Society cannot function without them. We need to own, maintain and improve them. Regulators across Europe seem to understand the need for improvements, which will create opportunities for a fair level of return.

Extract from Infrastructure Investor April 2026 magazine