Infrastructure has become increasingly popular with investors looking to improve the resilience and diversification of their portfolio via exposure to an alternative asset class.
Infrastructure can be broadly defined as being assets that provide, or facilitate the provision of, essential services that support economic growth and underpin the day-to-day operation of society.
We all utilise infrastructure assets every day when we use electricity, gas or water, when we go to schools or hospitals, and when we travel by road, rail, or air.
Investment in infrastructure helps stimulate sustainable long-term economic growth which then creates a further need for infrastructure.
Many consultants have completed extensive research into global infrastructure investment needs, demonstrating the significant amount required. McKinsey forecasts that US$57 trillion ($75 trillion) of investment is required to be invested in core infrastructure alone by 2030 just to keep up with expected economic growth.
Governments that are already heavily indebted can’t afford to spend the money themselves, infrastructure companies have to be part of the solution to fund this shortfall and are well positioned to benefit from attractive investment opportunities.
Infrastructure assets have a number of typical characteristics that complement a traditional portfolio.
PREDICTABLE CASH FLOWS
Infrastructure assets tend to have a high level of visibility and security with regard to future cash flows.
Their revenues are often underpinned by regulation or by long-term contracts with highly credit-worthy counterparties (which can often include governments).
This means infrastructure can provide investors with consistent and attractive income yields, which is something many investors are looking for in the current low-income environment.
INFLATION-LINKED
Revenue generated by infrastructure assets is often linked to inflation.
This inflation linkage can come about because rates of return set by regulators for regulated infrastructure assets are often linked to future inflation or under the provisions of a long-term contract.
This alignment with future inflation makes these infrastructure assets attractive to long-term investors who are looking to protect against the erosion of the value of their money over time by inflation.
SUSTAINABLE COMPETITIVE ADVANTAGE
In many instances, infrastructure assets enjoy a monopoly or operate in markets where the barriers to entry are high.
This means that the assets cannot be easily replicated and that they are often free from the competitive pressures that are faced by many more traditional companies.
LOW OPERATING EXPENSES AS A PERCENTAGE OF REVENUE
The primary cost of an infrastructure asset is its construction.
Once operational, an asset typically has low operating and maintenance costs.
LONGEVITY
An infrastructure asset will generally have a long economically useful life. For example, many assets have lives of 30-year plus and, in some cases, much longer.
Regular maintenance ensures that assets are able to operate for their entire expected useful life.
ESSENTIAL SERVICES
Infrastructure assets are essential to the operation of our society meaning that they are often less influenced by economic factors than many other businesses.
This feature can help infrastructure to deliver steady returns through market cycles.
Of course, as with any investment, it is critical to consider the risks.
The upfront and ongoing identification and management of risks is fundamental to successful infrastructure investment.
Typical risks that infrastructure assets may face can include interest rate sensitivity and refinancing risk, regulatory and political risk, liquidity, as well as asset-specific operating risks.
Until recently, infrastructure investment was only available to large institutional investors due to the significant amount of capital needed to make an investment.
Today, however, investors can invest in infrastructure through a number of managed funds and direct investment options making it more accessible.
Investors can access infrastructure via:
- Unlisted infrastructure funds, which offer the ability to implement a diversified portfolio in the short term and have a low correlation with other asset classes;
- Listed infrastructure securities provide liquidity and can enhance diversification across sectors and geographies but essentially reflect the volatility of listed equities;
- Composite funds incorporating listed and unlisted infrastructure have higher liquidity than direct investing while maintaining the key characteristic of direct investing; and
- Direct assets/separately managed accounts where investors invest directly or alongside other investors into infrastructure assets.
These approaches are usually only suitable for very large investors.
In recent times, the market has experienced significant levels of volatility.
The defensive characteristics of the infrastructure asset class means it tends to exhibit lower levels of volatility relative to many other asset classes, and is well placed to deliver steady returns through market cycles.
In addition, given the low correlation between infrastructure and other asset classes, such as the broader global share market and fixed interest, an allocation to the infrastructure asset class can help investors manage risk in their portfolios through delivering the important benefit of diversification.
Finally, the predictable and stable cash generative ability of infrastructure assets means it is likely that the assets can return consistent and attractive cash yields to investors, along with the potential for capital growth.
John Julian is portfolio manager of the core infrastructure fund at AMP Capital.
