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How is the infrastructure asset class expected to grow over the coming years?
Infrastructure is an asset class that is in a multi-decade secular growth phase. Estimates vary, however they all point in the same direction – the global stock of infrastructure assets is set to expand greatly over the coming years.
One set of calculations produced by a leading economic think tank estimates the global stock of infrastructure doubling to more than US$110trn over the next 15 years*. This is clearly demonstrated on the chart below, which shows the expected growth in the value of global infrastructure assets by sector:
Source: David Hale Global Economics (2014) and RARE, as at 31 December 2014. Past performance is not a reliable indicator of future performance. There is no guarantee that forecasts or estimates will be correct
This expansion will be driven by growth in both developed and emerging markets.
In developed markets there is a significant amount of expenditure required to bring existing infrastructure stock up to a standard that meets current needs (for example, we can see a fair amount of ageing road and rail infrastructure across many different developed countries). In addition, there is the investment that will be required to meet future needs.
In the emerging markets, we see a significant amount of infrastructure asset growth, as a result of rising populations, urbanisation and the growing demand for cleaner energy and better transport links.
Alongside this, as government balance sheets have become stretched across the world there has been a focus on fiscal consolidation – with limited appetite for government investment in large-scale infrastructure projects.
This has led to the role of the private sector in the provision of infrastructure increasing, leading to significant growth within the listed infrastructure asset class, which is the area that we at RARE specialise in.
What are the advantages of investing in infrastructure?
Infrastructure has a number of characteristics that are attractive to investors, including a strong and stable risk/return profile, income, lower correlation to traditional asset classes and defensive qualities such as providing protection against inflation.
Taking each of these in turn: 
a) Stable risk return profile: As infrastructure companies are typically involved in the provision of an essential service (often over a long time period), backed by hard assets whilst having a degree of price certainty (e.g. a regulatory framework or long-term contract), we see the risk/return profiles on offer in the sector being stable over time. Whilst any return will involve some degree of risk, the nature of the asset class means that skilled investors can achieve a return that more than compensates for the risk incurred.
In addition, given underlying infrastructure assets typically have some degree of inflation-linkage built in through these regulatory frameworks or long-term contracts, infrastructure provides good protection against changes in inflation. At RARE we estimate that 70 per cent of the cashflows of companies invested in within our flagship Value strategy are either directly or indirectly linked to inflation.
b) Income: As discussed in more detail below, infrastructure typically provides a significant income over time, given the recurring and growing dividends paid by many companies within the opportunity set.
c) Lower correlation to traditional asset classes: Infrastructure can act as a good diversifier in a portfolio, given its lower correlation to asset classes such as equities and bonds. This is a result of the underlying return streams of infrastructure companies being strongly linked to the regulatory or contractual frameworks in place, rather than typical drivers of equity and bond returns.
Even more importantly, we frequently see this diversification benefit increase in times of market stress, meaning that infrastructure provides protection through diversification exactly when it is needed the most.
3. What role can infrastructure play in the role of a growth/income investor?
Infrastructure has characteristics that make it well suited to both growth and income investors. At RARE, we typically split our investments across two different infrastructure asset types; user pay assets and regulated utilities.
The user pay assets are those assets that are involved in moving people or goods around an economy (for example companies that operate road and rail networks, airports, and ports). These companies are typically growth exposed, and can experienced significant capital appreciation over time, meeting the needs of growth investors.
The other main infrastructure asset type we invest in is regulated utilities (e.g. energy and water companies). As these are companies which typically pay a recurring and growing dividend, these meet the needs of income investors. Therefore by investing the portfolio across both asset types, we are able to meet the needs of both investor types.
4. Where do you think infrastructure should sit in a portfolio?
This depends on a number of factors, the first being the type of infrastructure that we are referring to (i.e. listed vs unlisted).
For the purpose of this response, let’s assume we’re referring to listed infrastructure (investments in the equity of companies that are involved in the provision or maintenance of infrastructure). There are then a number of other factors at play, including investment horizon, and the tolerance an investor has for risk/volatility within the different segments of their portfolio.
Typically we see investors with longer term horizons put listed infrastructure into the alternatives portion of their portfolio (sitting alongside unlisted infrastructure, property and private equity).
However, for investors that can’t tolerate volatility within that part of their portfolio, we see them putting listed infrastructure into the global equities bucket; effectively carving off a segment of lower risk exposure within global equities for listed infrastructure.
The other section of a portfolio where it’s appropriate to put listed infrastructure, is within ‘real assets’. This reflects the hard assets that are owned by the companies in which we invest, along with the often inflation-linked cashflows provided by these assets.
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.
*Source David Hale Global Economics, 2014
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This document is based on an update from RARE Infrastructure, a subsidiary of Legg Mason. The information and data in this material has been prepared from sources believed reliable but is not guaranteed in any way by Legg Mason Investments (Europe) Limited nor any Legg Mason, Inc. company or affiliate (together “Legg Mason”). No representation is made that the information is correct as of any time subsequent to its date. This material is not intended for any person or use that would be contrary to local law or regulation. Legg Mason is not responsible and takes no liability for the onward transmission of this material.
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