"Essential" assets that probably belong in your portfolio
Whether you’re looking to branch out into equities after holding a heavy focus on fixed-income, or want to “de-risk” your existing stock exposures, infrastructure assets have a role to play in all balanced portfolios, says Sarah Shaw, CIO and portfolio manager, 4D Global Infrastructure.
Why is infrastructure usually regarded as a defensive play? It hinges primarily on the essential nature of the underlying assets, explains Shaw. To define it, she starts with two broad categories of:
- Regulated utilities and
- User-pays assets.
Examples of the former include the power stations, wind farms or water treatment works we all rely on. The second category refers to assets such as airports, toll roads, ports and communications towers.
As Shaw explains, shifting exposure between the above categories during the depths of the COVID market downturn allowed 4D to avoid the worst of the fallout, which saw between 35% and 50% of the value wiped off stocks such as Sydney Airport (ASX: SYD).
“We increased our exposure to utilities at the height of the shutdown but didn’t entirely sell out of assets such as airports,” Shaw says.
“We thought the equity market correction was totally disproportionate to the value correction and so maintained some of the very oversold user-pays assets.”
In the following interview, Shaw lists four things her team looks for in listed infrastructure assets and explains what the return of inflation means for the sector. She also details her belief that nothing is “structurally broken” about airports or other parts of the thematic that have been knocked so hard since March 2020.
Can you define infrastructure for us as an asset class?
Sarah Shaw: Infrastructure's known as a defensive asset class with low volatility of earnings and a higher yield relative to general equities. It's known as a defensive asset class because of quite unique investment characteristics, which all work together to provide you with that long term visible or resilient earning stream.
What are those characteristics? When we screen our very broad universe of infrastructure-like stocks to get to our core investible universe, we're looking for things like monopolistic market positions or those with high barriers to entry.
We're looking for earnings that are underpinned by contracts or regulations. We want the high upfront capital cost, but then very low maintenance spending and a largely fixed operating cost space. And we want an inflation hedge. All these characteristics come together to provide that visibility in your earning stream and that defensiveness that investor's want.
At 4D, having screened a very broad universe of stocks that gives us a core investible universe of about 300 stocks, which is into two very broad sub-sectors. One is what we call “essential services,” which are your regulated utilities in the gas, water, and power space, and the other is what we call user pay assets, which are your toll roads, your airports, your ports, your rail operators and sort of communications infrastructure. So that's how we define infrastructure. It's really about a case-by-case assessment of the assets to give us those defensive characteristics.
What benefits does infrastructure provide to investment portfolios, especially compared to other defensive asset classes?
Shaw: Our view is that infrastructure has a place in all balanced portfolios. What it adds to a portfolio or how it should be positioned within an individual's portfolio really depends on the starting point of that portfolio.
So, infrastructure could be used to add liquidity to an otherwise illiquid allocation. It could be used to add equities, for that first move into equities for a very defensive bond portfolio.
It could be looked to add or “de-risk” the equity component of a portfolio. You could add some global exposure to a domestic portfolio or even just add yield to a portfolio. So, infrastructure has several places and is that defensive asset class relative to other defensive asset classes.
It has the real ability to actively position for the economic cycle, as well. So, it gives you defensiveness. It gives you the actively-managed ability and also gives you a huge growth pipeline because there's so much infrastructure investment needed in the world.
For us, it has a place in all balanced portfolios. And importantly, I think we are seeing increasing recognition of that because the asset class is being considered its own now. So, we're seeing people really see that as a real asset class.
How has COVID changed, particularly user pays, infrastructure assets? I'm thinking about airports, people are flying less. How are you viewing those assets now compared to utilities and other infrastructure assets?
Shaw: It's a good question. A great way to think about it is the shift of the portfolio that we've had from 2020 to today. For user pays assets, COVID was an unprecedented event. It was short, hard, and painful as of March 2020. And it really hit earnings hard for those users pay assets. Flights were grounded and there were no cars on the road – that was a real earnings impact and it required a real valuation shift. So, we definitely saw user pay assets suffer as a result of those closures, lockdowns and quarantines.
And by contrast, the utilities held up very well, because their returns don't rely on volumes and don't rely on people on the roads.
From that point of view, we can actively move between those two subsets. So, in 2020, when all this kicked off and we really saw economic upheaval over the next few months, we went overweight or increased our exposure to utilities in trying to weather that storm of the economic shutdown.
But we didn't sell off from what we considered to be very oversold airports. We thought that the value correction or the equity market correction was totally disproportionate to the value correction. So, we did maintain some really oversold user pay assets.
But since then we've seen the vaccines come out, we’re starting to see economies reopen, and there's huge pent up consumption demand out there.
We're seeing huge amounts of stimulus flow through into the economy. And we're seeing inflation come back. For us, that’s very supportive of having exposure to user pays assets, an area we’re now overweight. We’re positioned for not only that return of travel consumption stimulus but also the return of inflation.
Did the depressed valuations on used pay assets present buying opportunity for you guys at all?
Shaw: It was a huge buying opportunity. And I think airports are probably the best example of that. When we saw the March correction, they sold off by 35, 40, 50%. Now yes, the earnings impact on those airports in 2020, 2021 and even now 2022 is harsh, really harsh. And it does warrant evaluation adjustment. But you've got to keep in mind, these assets are 50, 60, 70-year assets.
So, there was nothing structurally broken about the airport thematic. So yes, while there was a valuation correction needed, it was completely overdone. For us, keeping in mind that we don't believe that there's a structural shift in airports, we saw that it's a real buying opportunity and we're starting to really see that traffic come back. We're seeing it come back faster than people anticipated. We saw the airports react really well to the situation they were in and they should emerge stronger. And in a better position because of this phenomenon.
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4D, a Bennelong Funds Management boutique, invests in listed infrastructure companies across all four corners of the globe. For more insights on global infrastructure, click the 'FOLLOW' button or visit 4D’s website.
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Glenn Freeman is a content editor at Livewire Markets. He has around 10 years’ experience in financial services writing and editing, most recently with Morningstar Australia. Glenn’s journalistic experience also spans broader areas of business...