The infrastructure assets set to boom in a global growth environment
The hunt for yield is a topic on everyone's mind. Record low-interest rates mean that traditional risk-free assets are no longer a viable way to compound your portfolio's returns over time. This is where defensive staples such as infrastructure investment can flourish: the upside of equities alongside a consistent stream of income. And in light of US President Joe Biden's trillion-dollar infrastructure package, the catalysts driving continued interest in the sector are inevitable.
"An ageing infrastructure inventory, a growing global population and evolving thematics such as the growth of the middle class, especially in emerging economies, and evolving global decarbonisation goals, demand a huge amount of infrastructure spending."
In this Fund Manager Q&A, Sarah Shaw, chief investment officer and global portfolio manager at 4D Infrastructure, explores the importance of infrastructure exposure within a portfolio, core pillars of growth within the sector and a special Spanish stock promising to be the “utility of the future.”
What initially attracted you to infrastructure as an investment class?
Infrastructure’s unique defensive investment characteristics (monopolistic market positions, high barriers to entry, regulated or contracted returns, inflation hedges) work together to provide long-term, resilient and visible cash flows which underpin a yield or potential yield. This in itself is attractive.
However, infrastructure offers much more than a defensive allocation. The combination of those attributes, the huge and growing need for infrastructure investment globally and the diverse nature of the assets within the infrastructure universe, will see infrastructure as a fantastic investment opportunity for decades to come.
With active management, an infrastructure portfolio can be positioned to take advantage of the long-term structural growth opportunity, as well as whatever cyclical events 2021 and the future throws at us – whether they be economic, political or environmental. As an investor, this makes the asset class a very compelling investment destination.
What role does infrastructure exposure play within a portfolio?
We strongly believe there is a place for listed infrastructure in all balanced portfolios and in all markets. As discussed above, infrastructure offers defensiveness with growth and sector and regional diversity, meaning it can be positioned for all points of an economic cycle.
The infrastructure asset class offers two distinct and economically diverse sub-sectors. ‘User Pay’ assets are, as the name suggests, those where the ‘user pays’ for access to the infrastructure service, such as airports and toll roads. Performance of these assets is correlated with economic growth. Then there are the traditional ‘Regulated Utilities’ where performance is largely independent of the macro environment, with returns measured independent of volumes. Active portfolio management of these two infrastructure sub-sectors across various regions smooths the volatility of equity investment and market cycles. We believe infrastructure is unique as an asset class in offering this true portfolio flexibility.
Funds for an infrastructure allocation can be sourced from cash, global equities, debt, bonds or alternative allocations, depending on an investor’s starting point. An investment in listed infrastructure can be used to:
- Provide liquidity and diversity to an overall infrastructure allocation
- Provide the first step into equity markets for a defensive portfolio sitting in bonds
- Add a defensive element to an equity portfolio
- Add regional diversity to a domestic portfolio; or
- Add yield while reducing volatility in a portfolio.
How has your philosophy/approach to investing in this area changed over time?
4D is a truly global, index agnostic, active manager of the global listed infrastructure asset class. Our philosophy is quite simply to give investors access to the best opportunities globally within the listed infrastructure space, for whatever point of the market/economic cycle we are in. This philosophy has remained unchanged over time, but our positioning has shifted within the definition of infrastructure to capitalise on the current macro-economic opportunity set.
One area of our process that has evolved since inception is our transparency around ESG. ESG has always been integral to our process, but as it has increasingly become important to investor decisions we are continuously growing and improving our reporting of our portfolio’s ESG outputs.
When looking for prospective opportunities, what are some of the attributes that you initially screen for/against?
We have a pure play definition of infrastructure. Any prospective opportunity must meet this strict definition and provide the long-term, visible and resilient earnings streams we require from the asset class – this is a critical screen.
We also screen on liquidity and trading volumes as well as ESG elements such as sanctions and reporting data.
Identification of opportunities and screens remains consistent between our global and emerging market strategies. I will comment, though, that across both strategies the country itself must be an acceptable investment destination before we invest – if a country is considered unacceptable, we don’t even look at the stocks in that country.
You recently published your ‘2021 infrastructure outlook,’ could you summarise the most important themes that investors must keep an eye on?
The opportunity for global infrastructure investment over the coming decades is simply huge.
An ageing infrastructure inventory, a growing global population and evolving thematics such as the growth of the middle class, especially in emerging economies, and evolving global decarbonisation goals, demand a huge amount of infrastructure spending.
These long-term thematics have only been enhanced by the COVID-19 pandemic. Huge government stimulus programs are fast-tracking infrastructure investment (in particular the energy transition); increasingly stretched government balance sheets will see a greater reliance on private sector capital to build much-needed infrastructure, and a ‘lower for longer’ interest rate environment is supportive of infrastructure investment and valuations.
This leads to an enormous opportunity for private sector infrastructure investment. We can think of no more compelling or enduring global investment thematic for the coming years.
While our positive macro outlook has broadly held true, we don’t ignore the risks. We’re currently monitoring whether the world is exiting COVID-19, or if these apparent new ‘strains’ are going to prolong the battle; and how long and how strong will governments and central banks be in providing ongoing fiscal and monetary support.
Finally, an emerging issue is the direction of interest rates and inflation, which have both shown recent signs of moving northward. We are actively positioning for all these themes.
Could you share an example of a company that you consider to be of outstanding quality? What initially attracted you to it and what are its future growth prospects?
Our top utility pick is Spanish-listed Iberdrola (BME:IBE). Within our utility exposure, we favour the integrated regulated names that are capitalising on the significant stimulus-led energy transition along with all parts of the value change – from renewable generation plants to strengthening the transmission/distribution grids, to managing clients. Iberdrola is a fantastic example – it defines itself as a “utility of the future”, with a strategic focus on transitioning to a full-scale sustainable energy model. Our investment thesis is premised on its:
- Diversified portfolio of utility assets across regulated, customer (legacy) and renewables sectors, with a focus on growth in regulated and renewables.
- Demographic diversification, with exposure and scale in core global renewable markets including Spain, UK, Germany, USA, Mexico, Brazil and now Australia.
- Leading position in offshore wind development – its scale and expertise shields it in part from increasing competition.
- Capitalising on the global energy transition thematic, which has been further enhanced by COVID-19 stimulus. To put this in perspective, last year Iberdrola announced a €75bn 5-year investment plan, of which 80% is already secured – and this plan grows to €150bn over 10 years.
- Strong existing Free Cash Flows (FCFs) and a solid balance sheet supporting this significant growth pipeline in well-positioned assets; and
- High-quality management team executing on strategic objectives, including strong communication to investors.
As such, we see Iberdrola as an under-valued, fundamentally attractive integrated regulated utility with a good combination of strong underlying FCFs, solid balance sheet, yield and a significant growth profile within environmentally friendly and sustainable sectors of the energy sector across the globe.
How does Australia’s infrastructure landscape compare to that globally?
In terms of current assets, Australia has some high-quality, well-structured contracted and regulated infrastructure assets on a par with its global peers.
However, in terms of forward thinking, while a $110 billion 10-year infrastructure plan may sound quite impressive, it still falls far short of global ‘stimulus’ driven infrastructure programs in absolute terms and as a percentage of GDP. For example, compare our 10-year A$110 billion (US$85 billion) plan to President Biden’s US$2.25trn plan to rebuild infrastructure and the economy, or the EU’s 7-year €1.1 trillion (US$1.3 trillion) budget and €750 billion (US$900 billion) Next Generation EU recovery plan. Even compared to our more like-for-like peer, Canada, we fall short relative to their C$70-100 billion 3-year plan.
Taking this a step further, Iberdrola, has a €75 billion (US$90 billion) 5-year investment plan and a €150 billion (US$180 billion) plan over 10 years.
That is a single company spending more than twice that of the Australian government in infrastructure deployment over the same period – and they will be held accountable. Putting it in this context, the $110bn (with little accountability) seems a bit light.
How does infrastructure tend to perform in a scenario where there is significantly less stimulus flowing into the space?
Increased public sector infrastructure spending is a clear positive for the broad infrastructure sector for a variety of reasons, including:
- Boosting economic growth and labour efficiency, which is good for all businesses but especially those infrastructure businesses which form the ‘arteries’ of an economy;
- Creating potential new opportunities for the private sector to co-invest alongside government or invest in place of governments; and
- Providing a bigger pool of privatisation candidates on a longer-term basis,
When stimulus decreases, some of the above factors won’t be as immediately supportive for the broad infrastructure asset class. However, the investment need remains huge, with or without stimulus, and the listed infrastructure sector will continue to capitalise on decades of necessary investment. Organically, we expect the asset class to perform in line with economic drivers. In a strong economic growth environment, even without significant stimulus, User Pay assets will perform well due to their correlation with economic growth, while Utilities are the place to be in sluggish macro environments.
Invest across the globe
4D Infrastructure is a Bennelong Funds Management boutique that invests in listed infrastructure companies across all four corners of the globe. For more insights on global infrastructure, visit 4D’s website.
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