Written By: Stephen Hearle
Stephen Hearle of Nordea Asset Management UK looks at the stability and potential returns offered by listed infrastructure – society’s essential systems, assets and facilities
When governments first began widespread privatisation of previously publicly-owned infrastructure assets, such as the UK’s privatisation of gas, water and electricity companies in 1980s and 90s, investors saw these equities as quasi-bond income generators. They were safe and reliable investments, but subject to periodic regulatory risk. They’ve been around for decades. So why is listed infrastructure a new buzz-word? Has anything really changed?
What is listed infrastructure?
Infrastructure can be defined as the essential systems, assets and facilities needed by a society to function.
The main thing that has changed in the last 25 years is the kind of assets that are categorised as listed infrastructure. With widening private participation in large-scale investment and increased globalisation, the scope of infrastructure assets has broadened significantly. What were originally basic utilities now includes the roll-out of new green power sources such as solar, wave and wind farms. Midstream energy is now considered infrastructure too, including pipelines and transport, storage and processing. Communications – once just the provision of your phone line – now includes satellites and towers, data hubs and fiber networks. Transportation infrastructure assets include not only railways, but also ports, airports and toll roads.
The asset class now looks quite different from the days when one could shrug off infrastructure as boring utilities that needed little more than dividend discount models to value.
Why is infrastructure interesting?
What makes infrastructure assets so attractive to private financiers is the long-term and stable nature of the revenue streams they generate. Infrastructure projects require a large up-front capital investment in physical assets – this provides a high barrier to entry. They are typically monopolies or near-monopolies, and they are either regulated or have long-term contracts with their customers, leading to good price control. Most of these services have a stable (read: resilient) demand pattern, making such assets defensive in economic downturns. The Covid-19 pandemic has illustrated that this is not always the case, particularly airports, but the majority of infrastructure assets have held up well against this year’s economic shock.
The infrastructure market as a whole is large and growing. The World Bank forecasts that global infrastructure needs will require $94 trillion of investment by 2040.¹ Moreover, most US infrastructure was built after World War II, and America needs $4.5 trillion in spending by 2025 for repairs.² Global stockmarket value of listed infrastructure has grown by 9.8% p.a. over the last 25 years, growing from $400 billion in 1995 to $4,100 billion in 2020³.
As listed equities, infrastructure companies tend to feature certain common characteristics that stem from the nature of their underlying businesses. They are typically cash generative with high dividend payouts which are able to keep up with inflation because of their contract pricing. The regulatory structures that some of these industries face (the penalty for their monopoly status) ensure that the businesses – and their investors – have medium-term visibility of returns.
A real asset or a bond in disguise?
While many do view some of these equities as offering bond-like characteristics, due to their relatively stable share prices and positive cash-flows, the inflation protection that many of them have through their long-term contracts means that their yields can grow over time.
Since 2007, infrastructure dividends have enjoyed a compound annual growth rate of 7%.⁴ This has meant that over the last 20 years, income growth has accounted for approximately 50% of listed infrastructure’s total return. Despite this dividend growth, while infrastructure equities have historically yielded around 1.7% below their corporate bonds, at the end of June 2020 Global Listed Infrastructure equities offered a higher yield than their bond equivalent.⁵
Moreover, while certain businesses within the sector – such as electricity and gas providers – are most likely facing fairly static demand levels albeit with inflation-protected prices, innovation and development means that others, such as telecommunication providers, are very definitely exposed to demand growth. The move towards decarbonisation around the world is another driver of growth for the industry. Public efforts to reduce carbon emissions are driving asset renewal programmes that include greener technology. Because these investments will be allowed to generate returns above their cost-of-capital, they will deliver longer-term growing returns for these companies.
What role can listed infrastructure play in a portfolio?
Within an equity portfolio, there is no doubt that infrastructure holdings tend towards lower volatility and steadier dividend streams (usually valued at a generous yield) than the broader market, making them sit well in the lower-risk category of equities.
FTSE Russell demonstrated in its 2019 paper “Practical Consideration for Listed Infrastructure” that the maximum drawdown of listed infrastructure indices was considerably lower than the drawdowns experienced by global equity indices. Over a nearly 15-year period⁶, the FTSE Global Core Infrastructure saw a maximum drawdown of 42%, while the FTSE Global All Cap Index saw a maximum drawdown of 58.4%. However, the asset class doesn’t stand out purely for its downside protection.
In the 20 years to June 30, 2020, global listed infrastructure has captured only 65% of the downside of global equities while participating in over 80% of the market upside.⁷ This highlights the diversification that global listed infrastructure can bring to a portfolio. According to specialist infrastructure investors CBRE Clarion, the correlation between global listed infrastructure and US Large Cap (Russell 1000 Index) is 0.74 over 10 years (slightly less over 20 years) whereas correlation with the Barclays US Aggregate Index was 0.26 over 10 years, 0.2 over 20 years.⁸
As part of an equity allocation, listed infrastructure offers an element of stability that begins to look particularly attractive to investors wary of potential market falls, while not eliminating positive returns should markets continue to rise. The growing cash-flows supported by long-term contracts and stable pricing provide not only a good ballast to a global equity allocation but also a lower-risk “real return”, and can bring a degree of diversification that could optimise a portfolio’s risk-adjusted returns⁹.
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3. Source: Global Listed Infrastructure Organisation, and CBRE Clarion. Period under consideration: 01.01.1995 to 01.01.2020
4. CBRE Clarion investable universe as of 12/31/2019
5. Source: CBRE Clarion, Moody’s Bond Indices Corporate BAA, FTSE Developed Core Infrastructure Index, FTSE Global Infrastructure Index of 06/30/2020. The performance represented is historical; past performance is not a reliable indicator of future results and investors may not recover the full amount invested. The value of your investment can go up and down, and you could lose some or all of your invested money.
6. 29.12.2005 to 19.05.2019
7. Source CBRE Clarion, comparing MSCI World Index against global infrastructure as represented by UBS Global Infrastructure & Utilities 50/50 Index September 2001 through February 28, 2015, and then the FTSE Global Core Infrastructure 50/50 Index from March 1, 2015 until 30 June 2020.
8. Source: CBRE Clarion, as at June 30, 2020.
9. There can be no warranty that an investment objective, targeted returns and results of an investment structure is achieved. The value of your investment can go up and down, and you could lose some or all of your invested money.