Building up assets in infrastructure

Fund managers who invest in infrastructure assets have determined that, contrary to last year’s historically low interest rate environment which helped stimulate strong appetite from both institutional and retail investors, this time around it will be sensitivity to the rising rates environment and how this impacts particular assets.

According to some managers however, interest rates were not the only factor that shaped investors’ behaviour over the last 12 months. 

“Interest rates will be the big theme, but there are many small things going on within the sector,” Zenith’s investment analyst Matt Cho said.

According to him, not all of the infrastructure assets, or listed infrastructure companies, were affected by rising yields in the same way.

He said that companies such as electrical and water utilities displayed traditionally higher sensitivity to interest rates while companies like toll road operators were characterised as being less sensitive and therefore more prone to benefit from overall economic growth.

Most experts also agreed that this asset class still demonstrated a very strong inflation protection and stable cashflows with good forecasts.

RARE Infrastructure’s portfolio manager, Shane Hurst said: “I think the way people should think about this is – briefly – these are very stable cash businesses so regardless of the moment of cycle you are in they still provide very good protection downside, protection from the economy shocks in the market because they are central to people to operate in the world.”

At the same time, according to investors one of the things that could potentially temper the global growth and therefore will become a bit of a concern for the asset class is the threat that inflation could come back and interest rates could start going up in circumstances where infrastructure is often seen as a bond proxy.

4D infrastructure’s global portfolio manager and chief investment officer, Sarah Shaw explained: “So we have been very overweight in the pay assets, we are not overweight in the in emerging markets where the growth has been very strong and that’s the earnings for those [infrastructure] companies that are very much linked to the macro cycle.”

On the other hand, according to some fund managers, such an environment could be potentially positive and deliver more opportunities for active management, particularly in the infrastructure space.

“I think a lot of investors might look at listed infrastructure [or] infrastructure in general, and think that because bond yields are going up, this is not a great asset class to be or it might sell off.

“In reality what it probably does do is it creates a bit more opportunity for active management,” Cho noted.

However, according to ETF Securities’ chief executive, Kris Walesby the misconception that active is better than passive when it comes to infrastructure assets is based on the fact that the ability to analyse the opportunity set of each company or project requires a deep knowledge of the country, government and population demand or supply profile. 

“The assumption is that applying a quantitative set of rules to select the company will be too blunt to select the best set of companies,” he said.

“However, when this is tested empirically by comparing index performance for a select set of infrastructure exchange traded funds (ETFs), it’s clear that many of the actively managed funds don’t perform as well and that, actually, being a successful active manager in infrastructure, and beating index alternatives, is a hard job.”

Misconceptions regarding infrastructure

According to fund managers, one of the most common aspects of investment in infrastructure as an asset class that investors needed to understand in the first place was that listed and unlisted infrastructure assets were basically the same.

According to RARE Infrastructure, despite the commonly-held view that unlisted assets were more valuable than listed ones, investors should remain aware that the underlying assets were exactly the same

“Sometimes you get better assets in listed vehicles than you do in unlisted vehicles but I would argue that this is the key misconception out there,” Hurst said.

According to him, another common issue that investors were faced with was that often the infrastructure assets were viewed as a part of the broader equity market.

“I think that there is a misconception out there about listed infrastructure as just another equity asset and it doesn’t need specific expertise and again I think that’s totally wrong,” Hurst said. 

He explained that the complexity of investing in utility assets required detail-oriented work and a specialist team who could understand the regulations and environment these assets operated in.

The rising bond yields and the potential impact they could have on infrastructure and utility assets was another misunderstood theme among investors.

“I think … a third [misconception] which is really important and very topical at the moment is that people assume that rising bond yields are negative for infrastructure and utility assets, when in reality you need to look at the underlying drivers of those rising bond yields,” Hurst said.

On the other hand, Cho warned: “I would say that one of the common misconceptions is that listed infrastructure doesn’t provide you with any benefit beyond broad equities, highly correlated to broad equity markets.”

“I think that this misconception is based on the fact that the infrastructure benchmark, an equity infrastructure benchmark, has been probably not very representative of the asset class infrastructure,” he said.

On the other hand, Walesby said that a common misconception among investors was that holding infrastructure assets in a rising rate environment was not good.

“That is not entirely untrue, it just basically focuses on only one part of the story.”

Walesby said that, normally, infrastructure assets had a very good demand profile in terms of how much demand they are going to have and what the money inflow is going to be, with the price more stable than other sectors.

However, in a rising rate environment the attraction of those assets might be a bit lower as investors are tempted to save money in the bank, for zero risk. 

“But as the cycle moves through you actually see the infrastructure assets gain more and more  profile with investors because there’s another side to the infrastructure that is not understood that much.”

He stressed that investors often overlooked the pricing power infrastructure assets have had and which “make them not so much a defensive asset but also in certain periods of cycle a growth asset”.

According to Walesby, one of the key advantages these companies have over other sectors was the fact that they were often monopolies or duopolies or they were government assisted, which put them in a unique position with an intense level of pricing power.

According to ETF Securities, although in general infrastructure assets were associated with consistent yields and low volatility, compared with other equity sectors, in a rate rising cycle investors could become concerned that the yields would be less appealing compared with risk free cash.

However, according to ETF Securities, there was also a second part of infrastructure investing with a leading driver being that many companies in that sector could continue to grow because of their pricing power.

So what is the current adviser sentiment?

According to Hurst, general current feedback from financial advisers was mixed, with many looking at the recent weakness in utilities which made them look attractive, given their valuations, while others were more concerned about rising bonds. 

“[Other investors] are concerned about rising bonds which goes back to that misconception that I think people still believe that bond yields rising would have a negative effect on these stocks,” he said.

On the other hand, according to 4D Infrastructure’s global equity strategist, Greg Goodsell, the overall level of understanding of the complexity that comes with investing in infrastructure was quite high among the financial advisers. “They [financial advisers] are pretty well informed in terms of what you get when you invest in infrastructure.”

Therefore, positioning infrastructure assets within the advisers’ portfolios was a highly individualised process and largely depended on their clients’ risk preferences, with advisers having different views on where those assets would best fit within their portfolios, the firm said.

“I think they all understand what infrastructure offers investors and what it offers you is a very defensive earnings stream, inflation hedge, and generally quite a solid yield, better than what you can get in the general equity market,” Shaw said.

However, according to Cho, infrastructure assets were definitely on a growth path, with current sentiment from financial advisers towards the asset class being “broadly positive.” 

“From my perspective I think it’s been a very popular asset class in Australia at least for the past few years, probably last five years,” he said.

“I think what people have been seeing is – they are looking at the amount of infrastructure spending that is going on within Melbourne or Sydney or they are looking outside at the US and see the budget that Trump has announced and the level of infrastructure spending that’s been planned and is that there’s always growth in infrastructure and how will I access this market?”

Cho also stressed that the Australian market was probably a little bit ahead of the curve, in terms of the way it has adopted listed infrastructure, with a high number of listed infrastructure managers being based out of Australia, while the US and Europe had “a little bit of catching up” to do in that area.

However, fund managers agreed that although infrastructure assets were an important addition to portfolios and defensive assets, investors wanting more diversity and exposure should look outside the Australian infrastructure market, which was quite limited.

Hurst said: “In terms of the Australian market, it is limited but globally obviously the universe is much larger. In Australia you are limited to Transurban or a toll road fund, maybe Sydney Airport, and then you have three or four utilities. So it is limited.” 

Shaw expressed a similar view, saying: “The Australian listed infrastructure market is relatively small so if they want diversity in exposure and liquidity they’d probably be better going to a listed infrastructure fund such as our own or unlisted infrastructure funds where you get that direct investment.”

Emerging markets

As far as other markets were concerned, feedback regarding emerging markets was rather positive with many areas still offering investors good opportunities which could be found especially in China, driven by its growing middle class which helped boost infrastructure growth in areas such as new airports and ports.

Another popular region that some funds had exposure to in terms of infrastructure assets was South and Central America, with a focus on countries such as Mexico and Brazil, which offered “fantastic utility assets” but which haven’t been properly analysed or captured by local markets and to which fund managers would hope to bring in their expertise. 

“We’re very positive on emerging markets infrastructure [and] think that it’s a great way for investors to get exposure in the emerging markets. They’re getting all the access to the domestic demand without the risks that often come with the emerging markets investors,” Shaw from 4D Infrastructure said.

“We do have exposure to China, we have exposure to Indonesia, we are actively looking at Latin America and across there – it’s Mexico, Argentina, Brazil, Chile – all look pretty attractive at the moment. 

According to 4D Infrastructure, the great opportunities for investors could be also found in Asia, in particular Thailand, Malaysia and India, as well as the Middle East.