The power of serial compounders

In the 13th century, the writer Ibn Khallikan records the story King Shirham, so enamoured of the game of chess he sought to reward its inventor, Grand Vizier Sissa ben Dahir. When asked to name his prize, Sissa simply asked for all the grains of rice that would fill a chessboard by doubling the grains on each subsequent square, beginning with just one grain on the first. His wish was granted until the quantum of the prize was determined: over 18 quintillion grains of rice.

While this may seem extreme, it makes a compelling point; that a relatively small advantage at the outset, if sustained, can compound into a very large benefit over time. Such compounding is one thing investors can’t ignore.

We see this principle at work in the outperformance of essential infrastructure in Chart 1, largely the result of Ausbil Investment Management's strict definition of the listed essential infrastructure universe that gives it an edge over others which can compound to a large difference over time.

Chart 1: Essential infrastructure: Limiting downside offers long-term outperformance against other asset classes

Ausbil’s strict definition of a listed essential infrastructure universe captures some 80% of the upside movements in global equities markets over time, while conceding just 47% of the downside movements of global equities, as illustrated in Chart 2.

Chart 2: 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 (Chart 1) and other, older listed infrastructure definitions, as illustrated by the indices in Chart 3.

Chart 3: How more tightly defined essential infrastructure outperforms index definitions over time

The steady compound outperformance of essential infrastructure as an asset class comes down to one important thing, the superior stability of cash flows generated by the earnings (represented by EBITDA) of infrastructure assets compared to the more lumpy and unpredictable flows from global equities, as illustrated in Charts 4 and 5.

Chart 4: The more stable earnings of essential infrastructure over the cycle…

Chart 5: …can translate into an edge that outperforms global equities over time

Chart 5 demonstrates the power of compounding these more stable essential infrastructure earnings cash flows, generated by infrastructure with regulated and contracted revenue streams, and why it pays to focus on companies that are serial positive compounders of cash flow. 

This would be the one thing we suggest to focus on in 2020: enlisting the power of compounding in your portfolio. 

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