The infrastructure conundrum

There is an extraordinary growth opportunity in infrastructure, writes Shane Hurst.

In emerging markets, population growth, urbanisation and increasing wealth are a catalyst, while in developed markets the upgrade of assets and innovative technologies are the big drivers. 

To put a value on how much new infrastructure will be needed to be built in these markets, RARE undertook analysis with Chicago-based David Hale Global Economics. The joint research showed that the total value of infrastructure assets would rise from US $49 trillion to US $110 trillion between 2015-2030. Put simply, the value of global infrastructure assets will more than double. A 2016 report¹ from Citibank also put the figure of new infrastructure spend over the next 15 years at US $58.6 trillion. 

Only recently has infrastructure emerged as a stand-alone asset class, with many large institutions having made sizeable allocations within their portfolios. For the most part these allocations have been directed towards private market transactions and unlisted infrastructure funds.

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The conundrum emerging in unlisted infrastructure is that increasing demand for unlisted infrastructure assets has not been met with an equivalent increase in the supply of suitable infrastructure opportunities. Listed infrastructure is only now gaining traction as an attractive alternative for investors wanting to invest in the asset class.

Listed infrastructure provides infrastructure investors with access not only to an additional suite of assets, but also provides regional and sector diversification across the infrastructure asset class. When managed correctly, listed infrastructure can provide investors with a broad, deep and liquid range of infrastructure investment opportunities with the liquidity unlisted investing does not provide. 

All things being equal, the ownership structure of listed or unlisted infrastructure does not change the underlying asset characteristics and operating cash flows. However, it is important to consider the meaningful differences in the risk exposures of the two universes which can lead to different observed performance.

While listed infrastructure assets may trade like equities in the short-term, largely due to the influence of index-aware equity investors, in the longer term these stocks will reflect the value of the underlying infrastructure assets characteristics.

For long-term infrastructure investors, price volatility in listed infrastructure should provide opportunities to purchase infrastructure assets at attractive prices.

Additionally, the volatility in cash flow in the listed infrastructure space is below that of the underlying share price and shows remarkable resilience during periods of economic instability. 

Given that asset-level returns are very similar, the differences in observed returns from listed and unlisted infrastructure are unlikely to arise from the asset level performance and instead reflect short-term noise or volatility. 

Gearing choices that are taken at the investment vehicle level can also impact returns, as well as any measurement bias based on time intervals. As the time horizon extends, investor returns become more heavily influenced by underlying asset performance.

In a recent research report, RARE examined the trading and transaction multiples across six major global infrastructure sectors. This research showed persistent evidence of pricing disconnects between listed and unlisted valuations, especially in sectors with a structural undersupply of assets. In sectors of chronic undersupply, unlisted transaction multiples have consistently exceeded listed trading multiples.

The key risk to longer term investment performance is not the day-to-day market volatility, but the risk of acquiring assets at excessive valuations. This risk is common across both listed and private infrastructure transactions. In an environment of significant demand for unlisted infrastructure assets combined with constrained supply, the risk of overpaying for assets is heightened. 

At RARE, we believe that by using a longer-term fundamental valuation approach when investing in listed markets through the cycle, significant opportunities arise as listed markets misprice infrastructure assets in the short-term. Through accessing listed infrastructure markets, RARE views both the liquidity and investable opportunity set as greater, further allowing for enhanced infrastructure returns to investors. 

Shane Hurst is senior investment analyst and portfolio manager at RARE Infrastructure.