The big inflation misconception deterring you from this asset

In an inflationary environment, you want to be aware of all your investment options. Is this myth standing in your way?
Sara Allen

Livewire Markets

Biases and myths are common in investing. After all, it is such a vast landscape that no one can truly be an expert on all aspects. This can see us using scrappy rules, that may have some hint of truth, to try and make sense of areas we don't fully understand. I hardly need to explain why this can be a problem. It can mean investors avoid assets that could be a useful addition to their portfolio – or on the flip side, use assets they might be better off avoiding.

While every type of investment has its myths and rules, infrastructure tends to be hit particularly hard by misconceptions.

Whether you see it as boring (subjective), expensive (depends on what you compare it to), or even have trouble identifying what even classifies as infrastructure (it’s vast…), many investors steer clear of this asset class. But none of the above is typically the biggest deal-breaker for investors.

Sarah Shaw, Global Portfolio Manager and CIO for 4D infrastructure, says the biggest misconception about infrastructure is the idea that it's a bond proxy. In a period of inflation and rising interest rates, you can understand why that view might deter many investors.

Sarah Shaw, Global Portfolio Manager and CIO for 4D Infrastructure

Infrastructure and the bond proxy myth

It’s worth going into more detail about the myth, so here goes.

When you think about infrastructure, front of mind might be highly regulated utility (nominal rate) companies where rates are typically set, and to change them might require certain policy levers which can be time-consuming.

In a period of rising inflation, it’s fair to assume that these types of companies might start to feel pressure. The cost to operate will be affected, while the returns the company makes will be devalued by inflation until such point the company is able to increase rates (depends on the policy requirements but can be a long time).

This is where the association with bonds comes in.

In a period of inflation and rising interest rates, a fixed-rate bond will still pay the same coupon – but inflation means that the coupon has a lower value for the investor. Should the investor want to sell the bond, its price will also have gone down. In simple terms, no one wants to pay a premium on a bond that pays 15bps, when they could pay that same premium for a bond paying 300bps.

Sounds like the myth is proven?

Not yet. Though it’s a fair point to make about nominal rate utilities which don’t typically have inflation indexing incorporated into their rates.

Looking at the broader infrastructure space

Shaw points out that nominal rate utilities are a very small segment of infrastructure, so grouping the entire space as a bond proxy isn’t an accurate comparison.

“We’ve got two distinct and economically diverse sub-sectors in infrastructure. On one hand, we have ‘user-pays assets’ like toll roads, airports, rail companies which are 100% correlated to economic activity and include explicit inflation hedges. They are also very high margin. In the current environment, they capture the growth and economic reopening, as well as inflation and compound this into their valuations,” Shaw says.

The second sub-sector Shaw looks at, she describes as "economically immune". This is where she groups essential services and basic needs. For example, water or electricity.

“These are your last resort in terms of affordability, the last thing you want to do is turn off your lights or water. The structure of their regulatory environment measures returns independent of volumes. Some of these could be considered a bond proxy - namely the nominal rate utilities. However, even within this sub-sector you have a segment that has an inflation pass through - the real rate utilities - which are not a bond proxy and offer solid upside in this environment,” says Shaw.

She also points out that regional distinctions mean you can’t universally apply thinking for either growth or opportunity. For example, while Europe is experiencing a challenging economic environment, Shaw sees massive opportunities in terms of energy infrastructure growth with accompanying government commitment to spending. On the flip side, she sees less diversity in the US and more nominal rate regulated utilities so it’s less of an opportunity set.

In short, the bond proxy comparison falls flat for vast proportions of the infrastructure space. You can see why the myth started, but applying it across the board is a mistake.

How to assess infrastructure (and avoid bond proxies)

Shaw’s approach to infrastructure requires companies to have a defensive, visible, resilient earnings stream. She also uses a 10-factor assessment of company quality considering industry structure, asset quality and responsible investment factors which is compared to the current valuations for the company to assess whether it is expensive or good value.

As part of the process, 4D factor the macro environment and assess individual country risks and opportunities before looking at the infrastructure companies.

“In the current environment, we are overweight user-pays asset and real-rate utilities and underweight nominal-rate utilities,” Shaw says.

You can find out more about the opportunities across the infrastructure space and using it in inflationary periods in this recent interview:

This could be the investment theme of the decade

Do you use infrastructure in your portfolio?

Let us know why or why not in the comments below.

Never miss an insight

If you're not an existing Livewire subscriber, you can sign up to get free access to investment ideas and strategies from Australia's leading investors.

And you can follow my profile to stay up to date with other wires as they're published – don't forget to give them a “like”.

Livewire gives readers access to information and educational content provided by financial services professionals and companies (“Livewire Contributors”). Livewire does not operate under an Australian financial services licence and relies on the exemption available under section 911A(2)(eb) of the Corporations Act 2001 (Cth) in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement. Livewire has commercial relationships with some Livewire Contributors.

1 contributor mentioned

Sara Allen
Content Editor
Livewire Markets

Sara is a Content Editor at Livewire Markets. She is a passionate writer and reader with more than a decade of experience specific to finance and investments. Sara's background has included working at ETF Securities, BT Financial Group and...

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.


Please sign in to comment on this wire.

trending on livewire
Get the best of Livewire by signing up to our popular daily newsletter