When most Australians think of defensive assets, they think cash or maybe fixed income. But there are other defensive alternatives that have offered higher returns than even global equities with, very importantly, relatively less risk than global equities.
Global listed property REITs and listed infrastructure are considered defensive, income-generating equities, offering a high dividend yield, underpinned by stable inflation-linked cash flows, and diversification from global equities. They are, essentially, a more liquid proxy for real assets.
Core infrastructure assets, such as electricity grids and toll roads, have reliable and predicable cash flows, with inflation linked revenues. Investors in global listed infrastructure, particularly listed core infrastructure have enjoyed superior risk-adjusted returns relative to global listed property REITs over the past decade.
In addition, core infrastructure provided better downside protection in falling equity markets as well as better diversification to global equities than listed property stocks.
Listed property and listed infrastructure have different risk and return profiles, so allocation to these assets should be considered separately, and there is room for both in a diversified portfolio.
Similarities and differences
Listed infrastructure and listed property are mature and deep markets with a market capitalisation equivalent to approximately 10% of the MSCI World Index - the global equity index representing the largest 1,632 stocks across 23 developed markets.
Both provide predictable, inflation-linked cash flows that are a good diversifier due to their relatively low correlation to global equities.
Risk and returns
While listed property has performed strongly over the past decade, listed infrastructure has outperformed, particularly core infrastructure, when looking through lenses such as return, volatility and downside protection.
For investors seeking income, listed property provides a consistently higher dividend yield compared to listed infrastructure and global equities. Many listed property companies are required to pay most of their income in distribution to their shareholders, and thus have very high payout ratios.
During the period from 2006-2018, listed real estate companies generated 65% of their total returns from the income component.
All asset classes experienced massive drawdowns during the GFC. But for core infrastructure, the magnitude of negative returns was smaller, and the recovery time quicker, compared to other asset classes. Listed infrastructure dropped 31% from its peak to trough during the GFC and took 22 months to recover. Global equities lost 51% of their value and took nearly four years to recover. But the listed property sector suffered the biggest drawdown, dropping 68% from its peak and taking more than five years to recover.
Diversification is one of the key considerations for long-term investors when investing in real assets. Defensive equities like listed property and listed infrastructure can reduce overall portfolio risk if they are sufficiently diversified from global equities. Otherwise they will simply add more equity beta to the portfolio. For infrastructure, this is why applying a clear and consistent definition is so important, and not straying into more industrial and infrastructure-like sectors.
Equity market beta
Infrastructure stocks have consistently maintained a beta of less than 0.6 in our analysis, meaning they are less volatile than the overall equity market. In contrast, property REITs have a long term average beta of 0.9 and carried a beta greater than one in the aftermath of the GFC until 2013, with this now dropping to below one.
With many forecasters expecting market volatility to increase into 2020 and beyond, the defensive characteristics of listed infrastructure and listed property are appealing. Listed infrastructure in particular, has consistently outperformed global equities over the past decade. There are, however, different definitions of what ‘infrastructure’ is, and investors with a focus on the defensive characteristics should consider looking for ‘core’ or conservative definitions. Given the less than perfect correlation between listed property and listed infrastructure, there is certainly room for both in an investor’s diversified asset portfolio.
Whitehelm provides investors with exposure to a diversified portfolio of global core infrastructure stocks. We invest in assets that protect the real value of the investment whilst providing predictable cash returns. For more information hit the contact button below.
Australian real estate and infrastructure assets proved to be highly correlated and fairly risky during the financial crisis, with insolvencies and multiple rounds of capital raisings to reduce gearing commonplace. Whilst gearing is much lower today, the test will be when interest rates increase. The stable yields and capital growth seen in recent years might substantially change then.
'Core' infrastructure is mentioned a number of times, but there is no explanation of how it differs from other 'non-core' infrastructure. If toll roads and electricity grids are given as 'core' examples, one would assume railroads and water utilities must be as well. That only leaves airports and communication towers from Table 1 as 'non-core'. An explanation, please.
Hi Graeme, we define core infrastructure as assets which have stable and resilient cash flows, with a monopoly position which allows the ability to pass on cost inflation. Toll roads, fully regulated energy grids, airports and some tower assets meet this definition. Non-core infrastructure would include things like data centres, power plants selling into unregulated markets, and some social infrastructure such as aged care facilities. Non-core infrastructure will tend to have greater exposure to economic cycles, and therefore can be less defensive and tend to behave more in line with broader stock markets.