Power companies are boring but critical; water is a liquid asset with a solid outlook; and mid-sized infrastructure opportunities are on the rise, say a trio of fundies from Resolution, Riparian and Palisade.

Speaking on day one of the annual Pinnacle Investment Summit, with a focus on real assets and infrastructure, three presenters each covered a part of these market segments.

Critical infrastructure is the portfolio bedrock for the funds offered by real asset specialist Resolution Capital. The manager’s Real Assets Fund is a professionally managed portfolio of AREITs and listed infrastructure companies, with exposure to office buildings, shopping centres, logistics warehouses along with airports, pipelines, toll roads and public utilities.

Predominantly ASX-listed, the portfolio includes dual-listed stocks and can also include an allocation of up to 20% offshore – but this weighting currently sits around 5%, says Resolution Capital portfolio manager Jan de Vos.

The Resolution Capital Real Assets fund’s biggest sector weighting is industrials, which comprise around 27%. Industrial REIT Goodman Group (ASX: GMG) was one of the fund’s top holdings as at the end of July, with an almost 24% portfolio weight that delivered 2.89% of the return.

De Vos believes real assets can deliver very attractive long-term returns but notes there are a few pitfalls investors need to watch out for.

  • Leverage. “This can kill an investment, particularly if it’s forced to recapitalise at the bottom of the market,” he says. This has been a problem for many AREITs in the past, but “pleasingly, many have now cleaned up their act,” De Vos says.
  • Poor governance. If management isn’t aligned with shareholders, it can cause major problems.
  • Yield obsession. Dividends are important, but they should be considered as part of the overall return mix rather than the only part.
  • Concentration risk. “Unfortunately, there aren’t too many local companies in this sector, but if you combine both infrastructure and AREITs, you get an interesting opportunity set,” De Vos says.

COVID-19 has turned the focus on a few specific types of real assets, including how office buildings will survive the transformation of Australian CBDs from bustling commercial hubs to barren ghost towns.

“This impact on the office sector has been important, but there’s something that’s more urgent, and that’s the new supply that is coming through. And that’s enough to make this supply-demand balance go in the wrong direction for landlords,” De Vos says.

“The vacancy rate in Sydney has gone from 3% at the beginning of the year to 7% currently, and both Sydney and Melbourne are on their way to double-digit vacancy rates.”

Office makes up around 2% of the Resolution Real Assets fund portfolio.

The energy sector, including renewables, is another theme captured by De Vos and his team. “The transition to the green economy, and the onset of emissions reductions targets, will have a big impact,” he says.

De Vos notes that renewable power generation is becoming increasingly cheap, the cost of solar and wind power having fallen 90% and 70% over the last decade.

“But we believe the returns are pretty skinny for what is actually quite significant risk,” he says.

“A better way to play this is through good old, boring utilities.”

Spark Infrastructure Group (ASX: SKI) is one of his preferred picks within the sector. “I think it would be difficult to find a company on the ASX with more predictable revenue than this one,” De Vos says.

The fund also holds some alternative listed property assets, including the Arena REIT (ASX: ARF). The biggest landlord of childcare centres in Australia saw dividend growth of 14 per cent in fiscal 2020. Some of the specific attributes De Vos likes are the underlying centre’s provision of such essential services, long average leases of 14 years and the strong government support that means childcare centres are quasi-regulated.

“They’re simple compounders over many years, these are the types of companies we’re looking for.”

Auckland Airport is another standout infrastructure stock, which Resolution ranks even more highly than Sydney Airport. Some of the features De Vos highlights include its high percentage share of the international passenger market, the airport’s ownership of excess land which enables it to be one of New Zealand’s biggest industrial developers.

“And it’s also geared toward growth in the Asia Pacific, with the region’s strong population and wealth growth,” De Vos says.

“Historically, airports have been very resilient, for example during 9/11; SARS and the GFC. And we believe there’s quite a lot of pent up demand for when people feel safe to travel again.”

One of the world’s most sophisticated water markets

An asset class that is largely separate from others, water is a vital resource for agricultural consumption. And Australian farmers of high value crops including citrus, almonds and table grapes continue to attract strong demand around the world.

“When we think about water, we see it as the most irreplaceable input into agricultural farming,” says Nick Waters, managing partner at Riparian Capital Partners.

Riparian is a specialist water, agriculture and food investment firm.

“Since 2008, yields in particular are one of the key attributes that make them compelling, especially in today’s low-yielding environment,” says Nick Waters, managing partner at Riparian Capital Partners.

“We continue to see increases in the crops being planted…and Aussie farmers are some of the most productive in the world, fully incentivised to continuing to deliver productivity gains over the next decade.”

The two key components of investments in water are:

  1. Water entitlements – permanent shares in the “airspace” of a particular dam or river
  2. Water allocations – the annual allocation of water volumes issue to entitlement holders.

The main short-term driver for water entitlement values is in relation to seasonal conditions – whether the weather has been wet or dry.

But over the longer term, the main drivers are the ongoing demand for Australian crops.

“Water markets are driven by how much farmers are prepared to pay,” says Waters.

“But demand for food both here and abroad is expected to remain strong and continue to increase the capacity for farmers to pay.”

Waters also refers to the high-profile review of the Murray Darling Basin water markets that was recently completed by the Australian Competition and Consumer Commission.

“This highlighted the importance of the water markets and confirmed the critical role that investors play in their function and efficiency,” he says.

“In our view, any regulatory risks have been significantly reduced with the recent ACCC report.”

As part of a broader portfolio, Waters believes water entitlements can deliver an improved liquidity profile, even versus traditional agriculture assets.

“The fundamental long-term drivers of water entitlements are in place and continue to support the value of this asset class well into the future.”

Why an active approach to infrastructure is vital: “these are not bottom drawer assets”

Also specialising in infrastructure assets, fund manager Palisade runs three strategies:

  • Diversified Infrastructure
  • Renewable Energy
  • Australian Social Infrastructure.

“With a core mandate of protecting investor capital, we recognise that infrastructure is essential in contributing to the efficient functioning of our economy,” says Roger LloydPalisade’s managing director and CEO.

“It’s not a homogenous asset class, and we look for long-duration asset streams – many of which have 99-year contract terms,” Lloyd says.

The manager’s focus on mid-cap companies is a conscious decision to maximise the number of assets and enable a focus on companies operating in less competitive environments with reduced pricing pressures.

Palisade also targets companies with high EBITDA margins that display high correlation to inflation and low correlation with other assets.

“We then combine that with active management – these are not bottom-drawer assets,” says Lloyd.

He doesn’t anticipate a slowdown in business opportunities within the areas of the market covered by Palisade’s funds.

“If anything, we see the opposite. We’ve all heard a lot about the infrastructure-led recovery, which means governments will be looking for private investment in the many shovel-ready assets that will be increasingly rolled out,” Lloyd says.

He also expects further opportunities to present themselves as the market begins to display distress. “Banks may lose patience with lower quality or highly leveraged assets over the next 12 to 24 months.”

Similar opportunities may also arise as corporates continue to look more closely at their balance sheets and divest non-core assets.

Pinnacle's 2020 Virtual Summit continues tomorrow

Throughout the week, Pinnacle will bring together some of the brightest minds in Australian investment management to help you build more robust, resilient portfolios. Tuesday's sessions will focus on both large cap and small cap Australian equities. Click here to register for both events and to view the full schedule.