The recent collapse in bond yields, driven by central bank rate cuts across many major economies, has increased fears of a global recession. This, in turn, has led to equity market volatility and growing expectations of a market setback, as investors seek safe-haven assets. However, we strongly believe that infrastructure equities will perform well in this environment, given their defensive characteristics, the relatively low exposure to wider macroeconomic factors, the secular growth drivers within the infrastructure sectors and the attraction of the underlying assets to investors seeking long duration, low risk assets as an alternative to expensive bonds. 
We believe that in the current environment, where sovereign and investment grade bonds are becoming increasingly expensive, we will see increased interest in infrastructure assets as a low risk alternative for long-term investors. There is nothing new here; the attractiveness of these assets to financial buyers such as sovereign wealth funds, pension funds and private equity investors (including Warren Buffet’s Berkshire Hathaway) is well-established. However, as falling bond yields make the need to find alternative investments more acute, we believe that attention will increasingly be focused on the listed infrastructure area, where relative valuations remain attractive despite recent strong share price performance.
It is instructive to note that two infrastructure equities, the Canadian energy midstream company Inter Pipeline and the US-listed renewable energy stock Pattern Energy, have each received unsolicited but confirmed bids from so-far anonymous sources since the beginning of August. We can’t be certain that these bids are from financial buyers, but this would be consistent with the trend of off-market bids for infrastructure stocks in recent months. Examples include IFM Global Infrastructure Fund’s $6.5bn acquisition of energy infrastructure stock Buckeye Partners and the Infratil/Brookfield acquisition of Vodafone New Zealand for NZ$3.4bn, both in May 2019, JP Morgan Infrastructure Investment Fund’s bid for the US regulated utility El Paso Electric for USD 2.8bn in June 2019 and Brookfield and GIC’s purchase of US railroad Genesee & Wyoming for $6.4bn in July 2019. In addition, we have seen numerous examples of private equity funds buying infrastructure assets from quoted companies, including Macquarie’s Green Investment Group buying a 40 per cent stake in Iberdrola’s East Anglia One wind project for £1.6bn in early August 2019.
So, what is the attraction of the sector to these long-term buyers, and why should investors see listed infrastructure stocks as a safe haven area? And how would we counter the view that these stocks are fully valued after strong recent gains? Taking the US regulated utility sector, the Miton Global Infrastructure Income Fund’s largest individual country and sector weighting, as an example, the sector is, according to analysts at RBC, trading close to its highest premium over the last decade versus the wider S&P 500 index.
In a recessionary environment, with many stocks potentially impacted by the negative consequences of a cyclical downturn, exacerbated by trade tariffs, we are likely to see earnings downgrades across the wider equity market. However, we are confident that, regardless of the macroeconomic background, we will see mid-single digit earnings growth from the regulated utility stocks over the next five years, and potentially beyond. This growth will come from rate base growth at the utilities, driven by two main factors. Firstly, the need to replace and maintain existing networks to continue to provide essential services and also to facilitate developments such as the widespread adoption of electric vehicles and two-way ‘smart-grids’. Secondly, to invest in the energy transition from coal-fired electricity generation to wind and solar, where the falling costs of these renewable technologies make this replacement cycle not only environmentally desirable, given the resulting reduction in carbon emissions, but also economically attractive in providing cheaper electricity to consumers.
This visibility of this earnings growth, which will happen regardless of macroeconomic cycles, trade wars or other external influences, is what could make this sector very attractive to long-term investors. Investors in listed infrastructure also get exposure to other areas of growth such as communications, and the huge growth in high speed fixed and mobile data, which again we believe is a secular trend which will continue regardless of a deteriorating macro-economic backdrop. So, investors get exposure to a combination of long-duration assets with the potential to provide resilient returns, but also to long-term growth drivers. In addition, in an environment of falling interest rates, many infrastructure stocks with investment-grade credit ratings can benefit from a lower cost of debt as they refinance existing bonds or use debt to fund the growth capital expenditure that we’ve highlighted. For regulated assets, the benefits of the lower cost of debt will be passed through to the end-consumers. However, for unregulated infrastructure assets, the lower borrowing cost will enhance equity returns, and, returning to the earlier theme, cheaper debt available to potential acquirers of listed stocks enables these buyers to pay higher premiums to the market value of equity.
In a severe equity market setback, there is no doubt that infrastructure stocks could be caught up in a wider tide of selling, and we could see share prices fall. However, based on the factors discussed, including the resilience of earnings, the ability to grow profits even in a recessionary environment, the positive influence of lower interest rates and the attractiveness as acquisition candidates to long-term financial investors seeking low-risk alternatives to fixed income assets, we believe infrastructure stocks have the potential to outperform the wider stock market in this scenario, and could provide a welcome safe haven for investors.
Jim Wright is manager of the Miton Global Infrastructure Income fund. The views expressed above are his own and should not be taken as investment advice.