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Global Infrastructure – The Forgotten Asset Class

Written by Ivan Fletcher

When looking at asset allocation we tend to think of shares property cash and fixed interest. However there is another assets class often over looked “Infrastructure”.

These investments provide essential goods or services to society that have a low level of sensitivity to the economic cycle, using contracted or regulated price structures which provide an inflation hedge.

WHAT ARE INFRASTRUCTURE ASSETS?   

Infrastructure are the physical assets that provide an essential service that we use and interact with every day  – broadly categorised into 2 categories :

  1. Regulated Assets  – Those essential services such as gas, water, and electricity which we use to carry out our daily activities.
  • A regulator determines the revenues that a company should earn on their assets. If an asset earns too much, then the company is required to return some of its revenues to its customers by lowering prices. Conversely, if the asset earns too little, then the company is able to increase its prices.
  • Because demand for these assets are steady and the regulator determines revenue, this mechanism leads to a relatively stable cash flow profile over time. Additionally, the regulator periodically takes into account inflation and bond yields, which means price increases are often linked to inflation and long-term valuations are relatively immune to changes in bond yields.
  1. User-Pays Assets – The physical assets namely rail, airports, roads, tunnels and bridges, and telecommunications towers, that move people, goods and services throughout an economy.
  • With user-pays assets, pricing is generally set by contracts, however volume and therefore revenue is determined by how many people use their assets.
  • Generally speaking, as an economy grows, develops and prospers, demand for these assets also typically grow.  For instance, as more people use, and to some degree depend on mobile phone data, we see mobile communications towers adding additional capacity to the physical towers to meet this demand.
  • Covid did have a negative impact on this component of infrastructure as the global economy literally stood still while we worked our way thru the early impacts of a highly contagious pandemic until vaccinations paved the way for the population to be again on the move.

SO – WHY INVEST IN GLOBAL LISTED INFRASTRUCTURE ?

Diversification

  • These hard structured assets provide a different element to a portfolio as the growth element is driven from structural rather than cyclical drivers.Long-term trends like urban congestion, globalisation of trade, security of energy supplies, and mobility of communications have placed enormous strain on infrastructure networks and will require investment over many decades. Backed by the right business model, this investment should result in strong growth for investors.
  • Infrastructure can act as a good diversifier in a portfolio, given its lower correlation to asset classes such as equities and bonds. This is because the underlying return streams are strongly linked to regulatory or contractual frameworks, rather than typical drivers of equity and bond returns. This diversification benefit increase in times of market stress, meaning that infrastructure provides protection exactly when it is needed the most.
  • Many companies in this sector are found in the mid-cap stocks and have non existent or very low weighting in traditional large Cap on Index biased portfolios. Many broader global equity managers may hold 2% or less of their portfolio in infrastructure assets.

Lower Volatility  –  Due to the essential nature of infrastructure assets, demand is relatively stable providing lower volatility than traditional equities and resiliency of infrastructure revenue during various business cycles. Even at times of economic weakness, consumers continue to use water, electricity, and gas, drive cars on toll roads and use other essential infrastructure services.  “User Pays’  assets suffered during the pandemic induced – lock Downs as physical assets such as roads and airports experienced low usage however they are now returning to the fore.

Stable Cash Flow  –  Infrastructure companies provide predictable income distributions due to stable earnings derived from the underlying asset.  Regulation and/or long-term contracts provide stable cash flow and greater capital stability. For investors, this provides excellent visibility for revenues and dividends.

Inflation Protection – Most infrastructure assets have an explicit link to inflation through regulation, concession agreements or contracts which provide inflation protection to investors.

SO WHY NOW – WHY 2023?

There are several tailwinds for the Infrastructure sector at play in 2023 and beyond :

Macro Growth Drivers

There are several macro secular growth drivers in 2023  for infrastructure that are based on a dire need for infrastructure spending which underpins growth for the next decade and beyond.    Mega themes such as decarbonisation, digitalisation and transport mobility all require heavy investment into new and existing infrastructure.

  • Energy security is currently driving policy decisions, and a significant amount of infrastructure will need to be built for nations to obtain it. High gas prices and supply constraints brought on by the Russia/Ukraine war have highlighted the importance of energy security and energy investment
  • In transport, changing trade routes and adjustments to supply chains to bring production closer to home, either through reshoring or near-shoring, are driving demand for new transport infrastructure.
  • Communications infrastructure continues to roll out 5G, develop 6G technology and work to reduce network latency, driving significant investments in wireless tower businesses, generally undertaken under long-term inflation-linked contracts.

Government – Fiscal policy Backing

Following years of under investment, a significant amount of infrastructure investment is now needed globally. Economic growth has been hindered in a number of nations due to critical infrastructure bottlenecks, particularly in the transport sector.

  • President Biden wants to reduce emissions in the U.S. by 50% by 2030, with roughly half of U.S. power coming from solar plants by 2050.
  • the U.S. Inflation Reduction Act (IRA), signed into law in August 2022, is the most significant climate legislation in U.S. history, with the potential to be transformative for utilities and renewables in particular.
  • The growing need for electrification — more electric vehicle charging infrastructure, more residential and small commercial rooftop solar — will require new substations, new transformers and upgraded wires along distribution networks. It will require nearly $320 billion to be invested in electricity transmission infrastructure by 2030 to meet net zero by 2050.  The first steps for meeting long-term climate and electrification goals are being taken now.

Economic Cycle –   Protection

  • The second phase of bear markets is generally an earnings recession which is expected to playout in 2023.
  • Infrastructure earnings however look better protected compared with global equities, particularly for our regulated assets, where the companies generate their cash flows, earnings and dividends from their underlying asset bases, where expectations are for those asset bases to increase over the next several years.   Most infrastructure companies have a link to inflation in their revenue or returns.

In Summary 

As the global economy works its way back to a new post pandemic normal, Infrastructure will play a key role supported by private Demand and Government stimulus alike and is an asset class to be included in your portfolio.

 

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