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Infrastructure is very broad area – how does RARE define the infrastructure universe?
“One of the first things that you realise when you start looking into the infrastructure asset class is that everyone’s definition of what ‘infrastructure’ is varies. Our view of infrastructure is as follows: we are looking for hard assets that provide an essential service to an economy and which have a degree of price certainty built in so that we know the asset is going to get paid for providing the service. It is this approach that forms the basis of our thinking.” 
“The infrastructure universe can be broadly separated into four main asset types: community and social assets, regulated assets, user pay assets, and competitive assets. We can split the universe in this manner because of the different types of assets that fall within each group, and their different characteristics as investments. It is important to do so because when investing in the asset class, you’re going to get very different types of risk and return profiles based on the type of infrastructure assets that you hold.”
“The first group, community and social assets, are those assets that many people will mention when you ask them to name infrastructure; schools, hospitals, and prisons are some of the main examples. These are assets which have traditionally been funded with public sector involvement, and which have a clearly visible beneficial impact on society, although for investors may offer low returns with limited growth potential.”
“The second group is regulated assets. These are assets that operate in a regulated environment; their operations, and therefore return profiles, are impacted by the regulator of their particular industry. The key examples here are energy companies (e.g. gas and electricity utilities which manage the gas and electricity networks) and water utilities. These companies are regulated because they typically operate in markets that tend to be natural monopolies. For example, the UK, like most countries, only has one national electrical transmission network which is managed and operated by National Grid.”
“The third group, user pay assets, are assets that are involved with moving people or goods around an economy. For example, companies that operate road and rail networks, airports, and ports. These companies are not regulated, however they often operate with concession based contracts; for example, a company may hold the lease to operate a particular toll road for a certain amount of time. User pay assets are more exposed to growth than regulated assets, as their revenues are typically linked to volume.”
“The final group consists of assets that operate in competitive markets, with exposure to wholesale prices, and typically without the security of regulation or concession contracts. An example here is energy generation and retail companies – rather than managing the energy networks, these are companies that create energy and sell energy to the end user. They are therefore subject to supply and demand risk.”
What kind of infrastructure investing does RARE Infrastructure specialise in?
“At RARE, we focus on investing in the regulated assets and user pay assets. We do so due to the fact that these companies operate either within a defined regulatory framework or with long-term contracts in place, which underpins the return profiles of these companies. The cash flows of these companies typically stretch out years and decades into the future (i.e. they have a long duration), and the frameworks that they operate in means that with the appropriate expertise it is possible to estimate these cash flows, and therefore the intrinsic value of the companies, with some degree of accuracy.”
“This means that the main types of assets we invest in include the regulated gas, water, and electricity companies in the regulated assets space, and then toll road, rail, port, and airport companies in the user pay space.”
“A key point here is that we generally invest in network industries; we prefer to own the pipes and the grids that bring gas and electricity (for example) to your house, rather than owning the company that actually sells you the gas and electricity. The rationale behind this is simple; network companies tend to offer a more stable and less volatile investment – you can change your gas or electricity provider if you wish to, however you’re unable to change the company that operates the network bringing gas and electricity to your house.”
How does this differentiate RARE from its competitors?
“RARE’s approach infrastructure investing in a unique way. We believe that when investors invest in infrastructure they are looking for a steady return combined with a decent level of income. They are not typically looking for volatile investments with a high degree of price uncertainty. This is why we focus on investing in those infrastructure businesses which operate in fairly stable regulatory or contractual frameworks, and which don’t have a large degree wholesale price exposure or supply and demand risk.”
“We also want to invest in companies whose revenues have low if not zero exposure to commodity risk. We recognise that at times commodities can provide investors good returns, but they can be highly variable and we believe that investors in infrastructure are looking for a stable and even slightly defensive return stream, which commodity exposure isn't compatible with. We therefore don’t invest in energy generation companies whose returns are materially impacted by changes in commodity prices whereas we know that others in the marketplace do.”
“In addition, our competitors often select their stocks from a universe set by traditional infrastructure indexes. We think many of these indexes contain companies affected by commodity sensitivity as well as asset light companies (e.g. airline services and logistics which can face strong pricing pressure and hence poor earnings visibility) which are not appropriate for us.”
“Given our clear vision on how we qualify infrastructure and the steady return profile it should exhibit, we have developed our own proprietary infrastructure universe which we call the RARE 200. This is the 200 largest and most liquid companies that meet our definition of infrastructure and from which we select the stocks to be in our portfolios. We believe this enables us to invest in the very best infrastructure assets that offer the stable and low volatility return profile that we believe infrastructure investors are looking for.”
Nick Langley is a founder, co-chief executive and co-chief investment officer at RARE Infrastructure. The views expressed above are his own and should not be taken as investment advice.
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