New wave of infrastructure investment

A new breed of infrastructure investment products combining the best features of unlisted and listed assets can reduce the risk and increase the returns of a theoretically-balanced portfolio, according to AMP Capital Investors head of portfolio management Paul Foster.

Speaking at the recent PortfolioConstruction Conference in Sydney, Foster said that although Australia has a relatively long history of infrastructure investment, it has traditionally been considered something of a ‘cottage’ asset class.

While the stability and diversification benefits of unlisted infrastructure and the liquidity of its listed alternative have long proved attractive to retail investors, many are turned off by the illiquidity of the former and the volatility and equity market beta inherent in the latter.

In addition, the high barriers to entry have made it difficult, if not impossible, for many retail investors to combine both unlisted and listed infrastructure in their portfolios, particularly on a global basis.

However, increased privatisation of the sector over the past four years has boosted its popularity as an asset class and spawned what Foster terms a new generation of products designed to harness the best attributes of unlisted and listed infrastructure, while diluting their less redeeming qualities.

A variety of indices have been created to track these products’ performance, however, Foster believes they are all either too broad or too narrow in scope.

Mercer research suggests superannuation funds’ average allocation to infrastructure has increased from just 0.7 per cent in June 2003 to 3 per cent in June of this year.

JANA, Australia’s largest institutional asset consultant, estimates that growing superannuation funds typically allocate between 5 and 10 per cent to infrastructure.

“A lot of the early [superannuation] investors are increasing their allocation to infrastructure, while funds that didn’t participate in the first wave are seeking to play catch up,” Foster said.

Investment banks have also paid far more attention to the asset class over the past three to four years. According to Standard & Poor’s, 27 new infrastructure funds were launched last year alone and investors worldwide have a collective pool of between US$100 and US$150 billion that they are seeking to invest in infrastructure.

This growth is also reflected in increased securitisation of the asset class on both Australian and stock exchanges.

Allocation to infrastructure increased from 1.1 per cent in June 2002 to 5.2 per cent in June of this year on the ASX 200 and from 4.2 per cent to 5.1 per cent on Standard & Poor’s Global Broad Market Index.

In Foster’s view, infrastructure can be a valuable addition to a diversified portfolio for several reasons. As investments are typically long-duration (upwards of 30 years), he said they are particularly well-suited to superannuation and retirement funds.

For starters, infrastructure comprises the provision of essential economic or social services, such as roads, airports, telecommunications networks, schools, hospitals and public housing, which are, or exhibit the characteristics of, natural monopolies.

This is to say they have high development costs (barriers to entry) and operate within regulated environments.

Although these regulated environments tend to shift income growth, infrastructure assets typically generate relatively high yields.

As revenues are linked to the Consumer Price Index (CPI), the sector has low correlation with more traditional equity investments and can therefore be used as defensive assets, providing steady returns throughout the economic cycle.

“Infrastructure assets are essentially protected from the vagrancies of economic activity,” Foster said.

On the flipside, however, infrastructure assets are negatively affected by interest rate rises, although inflation increases provide a natural hedge against nominal interest rate hikes.

Infrastructure assets are also relatively exposed to regulatory or political risk and large-scale disasters such as the September 11, 2001, terrorist attacks in the United States.

However, Foster said infrastructure typically recovers from these kinds of adverse events in less than 18 months.

Foster emphasised that the key to harnessing infrastructure’s intrinsic benefits and diluting its negative attributes is to package both unlisted and listed assets effectively.

This enables investors to reap the benefits of unlisted assets’ stable, uncorrelated returns, while using listed assets to offset their more negative attributes. Listed assets add liquidity and generally require less capital up-front than their unlisted counterparts.

AMP Capital is set to release a new infrastructure investment product in September this year, along with an index Foster said provides a more accurate definition of what infrastructure constitutes is than current indices.

In Foster’s view, a portfolio that allocates 10 per cent to infrastructure and splits unlisted and listed assets 50-50 is likely to produce the best results.

“Essentially, the asset class has a number of distinctive characteristics that make it an important addition to investors’ portfolios. If unlisted and listed assets are packaged effectively, [infrastructure investment products] can deliver on either a regional or global basis.”