The tailwinds to rising share markets are well known, with massive amounts of monetary and fiscal stimulus, and to a lesser extent increased savings rates and retail investor participation.

Delving into the detail, the rebound in equity markets has been predominately driven by a narrow segment of the market – US tech and other high beta sectors – which has significantly outperformed European and Asian markets. The US-listed mega-tech stocks, the “FAANG” stocks, now make up about 12 per cent of the MSCI World Index and the US market now makes up over 60 per cent of this index.

Seeking downside protection

Through February and March 2020, as the COVID pandemic took hold, global equity markets fell 13 per cent in Australian dollar terms. The FTSE Developed Core Infrastructure Index didn’t offer as much downside protection as history would lead us to expect, dropping by 12.7 per cent. The fact that this is a health crisis as well as an economic one meant that lockdowns hit transport stocks especially hard. Listed infrastructure has lagged broader global markets for several reasons: 

• The nature of this crisis has meant that transport infrastructure has been particularly hard-hit. For example, airport revenues fell to nearly zero and remain around 70 per cent lower than pre-pandemic levels.
• Toll roads and passenger rail have also been heavily affected.
• Immediate fiscal stimulus was rightly focused on employers and the consumer, while infrastructure will benefit from longer-term stimulus programs.

Apart from the transportation sector, the earnings from infrastructure assets have held up well, with utilities reporting earnings in the range of +5 per cent to -10 per cent.

The MSCI World Index aggregate weighted earnings have fallen 29 per cent over the past year. In contrast, the aggregate earnings of the FTSE Developed Core Infrastructure Index have fallen only 12 per cent, and the aggregate weighted earnings of the holdings of the fund that I manage – the Whitehelm Listed Core Infrastructure strategy – have fallen less than 10 per cent.

Despite earnings having fallen in most sectors (outside of tech and some healthcare and consumer stocks), global share markets are close to record highs, meaning that global equities have become much more expensive. The outperformance of the MSCI World over listed infrastructure is driven more from price/earnings expansion than from fundamentals.

The dynamics, which have led to the stunning return on equities over the past nine months, are also shifting. As vaccine roll-outs begin and economic activity picks up, some of the short-term stimulus that has been so supportive is starting to be wound back. 

Outlook

The valuation gap between global equities and listed infrastructure is now at extreme levels relative to historical averages. This potentially presents an opportunity for investors who are considering investing in listed infrastructure.

• The worst of the lockdown impacts have been absorbed by the transport infrastructure stocks.
• Core utility companies are generating consistent earnings.
• Core utility companies will benefit from longer-term stimulus dynamics.

Core infrastructure can provide strong risk-adjusted returns as well as an attractive relative income stream. For investors cautious about stretched valuations for global equities, listed infrastructure appears relatively cheap in comparison.