Infrastructure can provide defensive income, allow investors some participation in the upside of equity investment, and provide diversification from equities and bonds. It’s fair to ask then, why this asset class is ignored by so many investors... particularly at a time when ‘the search for yield’ has reached fever pitch.
Despite these characteristics, infrastructure fails to make an appearance in many portfolios. The ATO’s self-managed super fund quarterly report doesn’t even list infrastructure as an asset class, and Vanguard’s Diversified Balanced Index ETF has zero allocation to the asset class.
In the first of our three-part series, we asked four specialists in global listed infrastructure for their most compelling reasons to include this underappreciated asset class in a portfolio.
Responses come from Andrew Greenup, CFS GAM; Tim Humphreys, Ausbil Investment Management; Ben McVicar, Magellan Asset Management; and Warryn Robertson, Lazard Asset Management.
At the sweet spot of income and growth
Global listed infrastructure looks to protect and grow capital while producing an attractive dividend yield for investors. Infrastructure assets like toll roads, airports, railways, seaports, utilities, pipelines and mobile towers provide essential services. They typically exhibit high barriers to entry, inflation linked earnings, structural growth drivers and highly predictable cash flows in an increasingly uncertain world.
The most compelling reasons to consider global listed infrastructure as part of a portfolio are:
- In a low interest rate environment, global listed infrastructure provides a strong dividend yield of between 3.5% and 4.0%, with dividends forecast to grow at between 4% and 6% p.a.
- Infrastructure assets can often increase prices without destroying demand, owing to their essential service nature.
- Earnings are driven by structural demand (replacement of aged assets, catch-up of historic underinvestment, urbanisation, congestion relief, advances in mobile communications, renewable energy) and are not reliant on economic growth.
- Voters in both developed and developing worlds are demanding improved infrastructure. This is generally leading to bipartisan support (in an increasingly partisan political world) for additional investment into infrastructure projects, to improve lives and increase productivity. This is creating significant growth opportunities for listed infrastructure companies.
- Adding global listed infrastructure to an investment portfolio provides diversification benefits and reduces correlations of returns.
- Global listed infrastructure can expand the investment opportunity set by providing exposure to high quality assets not found in a typical Australian or global equities fund (for example: mobile towers; freight railways; oil and gas pipeline, storage & export firms)
These factors equate to a relatively low risk investment proposition that offers both inflation-linked income and structural earnings growth.
Source: Bloomberg and CFSGAM. Data as at 30 June 2019.
Capturing more of the upside than the downside
In the 13th century, the writer Ibn Khallikan records the story of the Indian King Shirham who was so enamoured of the game of chess he sought to reward its inventor, the Grand Vizier Sissa ben Dahir. When asked to name his prize, Sissa simply asked for all the grains of rice that would fill a chess board by doubling the grains on each subsequent square, beginning with just one grain on the first square. As the story goes, his wish was granted, until the quantum of the prize was finally determined, a total of 18,446,744,073,709,551,615 grains of rice. While this story is extreme, the most compelling point for investing in listed infrastructure is simply that a relatively small advantage at the outset can compound into a very large benefit over time.
The compounding advantage offered by Ausbil’s definition of the listed essential infrastructure universe is illustrated in Figure 1. In simple terms, listed essential infrastructure captures some 89% of the upside movements in global equities markets over time, while conceding just 50% of the downside movements of global equities, which translates to a basic advantage that results in a significant compounding outperformance over time. In other words, Ausbil’s tight definition of the essential infrastructure universe provides asymmetric returns skewed to the upside which is a major strength of this approach to the infrastructure asset class.
Figure 1: The essential infrastructure universe as defined by Ausbil: Capture of up and down-market movements
The result of this upside capture advantage over time for Ausbil’s definition of the essential infrastructure universe is well illustrated in the compound outperformance over other asset classes over time.
Assets that can perform, irrespective of the broader environment
Ben McVicar, Magellan Asset Management Limited
We have two key objectives when building portfolios of infrastructure and utility stocks (broadly defined as infrastructure assets); that is, deliver a reasonable return outcome and minimise ‘downside risk’. We consider that global listed infrastructure, when defined in a conservative and robust way, delivers on these objectives. We hold a view that ultimately cash flows drive security prices in the medium to long term. If we can get that piece right, then the reliability of investment outcomes follows. Due to this, we spend a lot of time trying to avoid risks that could derail that reliability. These include too much exposure to competition, exposure to commodity prices, and too much sovereign risk. Minimising these risks helps us to identify assets that have more predictable and reliable cash flows, which ultimately translates to our objective to provide reliable returns.
Investors don’t buy infrastructure and utility assets expecting outsized returns, but they do expect the assets to continue to perform irrespective of the broader environment. In terms of downside protection, our strategy has delivered a downside capture ratio of -0.1 over the past five years when measured as the average of months when the MSCI World Net TR (AUD Hedged) Index is down. This means that the strategy has had an average positive return during the negative months experienced by the index. As a recent example, in Q4 2018 the MIF infrastructure return (Net) was down only 2.1% vs the MSCI World Net TR (AUD Hedged) Index that was down 13.5%. This was also a better performance than what we have seen from the major infrastructure indices, which we don’t think always get the definition right.
A unique space between bonds and equities
Strategically, it makes sense for all investors to think about an allocation to Global Listed Infrastructure. This is because of the very simple reason that it sits in a unique space between bonds and equities on the risk/return spectrum.
If you think about bond investing, there is usually very little individual security risk, it is rare for a bond to behave in an unpredictable manner, the error bands around expectations are quite small. Naturally, this limits the upside potential or opportunity in this asset class. Listed equities sit at the opposite end of the spectrum; surprises (negative or positive) are the lifeblood of the equity market. Getting a company’s earnings and the multiple the market is willing to pay for these earnings is a constant challenge for any investor.
Listed infrastructure is a little different in that these companies should not have too much risk around earnings because their revenues are normally stable and arise from natural monopoly or regulated earning streams. This solves for one half of the equity market puzzle and theoretically make investing in this asset class less risky than general equities.
Historically, these risk expectations have been in-line with the return profile of listed infrastructure. When compared to other asset classes, listed infrastructure has provided investors with attractive returns with relatively low volatility. Therefore, we do believe that the long-term case for listed infrastructure within a broad-based allocation of global equities is compelling.
What is a more difficult decision is whether you should be overweight or underweight the standard allocation today. Today, in our view, all asset classes generally look expensive.
To be frank, at a headline level, listed infrastructure does not look overly attractive either. However, when you compare it with developed bonds and global equities, as an asset class, it stacks up much better. Principally because the earnings are likely to remain robust in a range of economic scenarios and compared with the average industrial company, you are not going to have the issue of large earnings downgrades many will face.
The issue for listed infrastructure is the multiple investors are willing to pay for those reliable earnings. Many listed infrastructure stocks are trading on too high of a multiple and these overvalued companies need to be avoided.
Listed infrastructure still makes a lot sense but only select infrastructure companies. You must keep an eye on valuation in this market today and that is going to force you to be quite concentrated, as there are very few listed infrastructure companies trading at attractive valuations. At Lazard, we run a concentrated global listed infrastructure strategy and we believe our portfolio looks relatively attractive when compared to a passive investment in infrastructure or broader global equity indices.
So, whether you’re looking for stability, diversification, or income, global listed infrastructure offers a unique mix of all three. As this chart from Morgan Stanley shows, it can be possible to eat one’s cake and have it too.
Keep an eye out for parts two and three of this special series on global listed infrastructure, where we’ll learn about some common misconceptions about the asset class, and our contributors will some of the unique opportunities available today.
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