Investors have been increasingly attracted to the potential predictable cash flows and steady income offered by tangible infrastructure assets, which also come with associated inflation-fighting characteristics, according to Ben Morton, portfolio manager of the Cohen & Steers Global Listed Infrastructure strategy.
The strategy provides access to infrastructure assets through a global portfolio of publicly-traded companies, “many of which feature relatively stable cash flows and monopolistic market conditions”.
“Infrastructure has undoubtedly been one of the most coveted asset classes in recent years,” Morton said. “The substantial investor inflows are understandable – as the space has historically delivered equity-like returns, but with lower volatility and superior downside relative to the broader equity markets.”
These assets, which are the facilities and structures providing essential services to the public and private enterprise, are essentially grouped in four main categories, he noted: mid-stream energy, utilities, communications and transportation.
“Due to the compelling characteristics of infrastructure, investors have clamoured to gain access to these assets, primarily through private markets,” he said, pointing out however that competition for assets is high in the private space, with more than $170bn of capital raised by private infrastructure funds sitting idle.
Performance of indices over 1yr
Source: FE Analytics
As private capital seeks to invest this ‘dry powder’, he said, recent private infrastructure transactions have commanded notable premiums to listed peers.
“Sophisticated investors are beginning to be wary of this frothy private investment environment and are seeking to increase exposure to more liquid listed infrastructure strategies,” the portfolio manager said.
Morton sets great store by infrastructure’s ability for downside protection amid potentially higher volatility.
“In our view, the defensive nature of infrastructure, due to the historical predictable cashflows of these assets, is going to be increasingly important over the next phase of the cycle – as the global economy transitions from what we believe will be above-trend to below-trend growth over the coming 12 to 18 months.”
Morton also stressed the importance of asset allocation in this sector. While the positive structural drivers of the asset class are increasingly accepted by investors, he noted, specialist active management in this space is crucial.
“The performance differential between the varied listed infrastructure businesses can often be vast, despite these assets sharing similar structural characteristics at a high level,” said the Cohen & Steers manager.
By way of illustration, he said that during the financial crisis, dispersion of performance between the sub-sectors – as measured in the difference in performance between the top and bottom performing subsector within the asset class – was about 50 per cent to 60 per cent, and that it has been at least 25 per cent every year since.
“Last year was no different, as the gas utility sub-sector delivered a positive return of 9.5 per cent in US dollar terms, while marine ports fell 16.7 per cent,” added Morton.
The fund manager said his team has grown more cautious on macro concerns.
“We have taken a more defensive stance within our infrastructure portfolios, given our view of a continued economic slowdown and rising political uncertainties globally,” he said.
He remains optimistic on US water utilities, with growth driven by critical pipeline replacement projects across the country. Consolidation of the largely municipally-owned sector is an additional tailwind, the Cohen & Steers Global Listed Infrastructure fund manager added.
Performance of fund vs index since launch
Source: FE Analytics
In addition, it is also seeing a secular tailwind for mobile towers as the demand for data continues to grow.
“Tower owners are well positioned to benefit from long-term secular demand growth for wireless data services and the adoption of next generation standards – such as 5G – which should drive increases in wireless carrier spending and leasing activity,” he explained.
Mid-stream energy is also a favoured subsector, which he said will benefit from two key themes: one, that the fundamental tailwinds are growing, and two, that management teams are transitioning to what he calls the ‘Midstream 2.0’ business model.
“This model recognises the importance of corporate governance and investor alignment, strong balance sheets, and return-based performance metrics,” he explained.
Viewing the sector’s short- to medium-term prospect from a UK perceptive, Philip Kent, manager of GCP Infrastructure Investments, noted that the government has identified a pipeline of around £600bn of new infrastructure development over the next decade, of which approximately 50 per cent is expected to come from the private sector.
“In addition, the UK has recently adopted a net zero emissions target by 2050, which requires a material investment in transforming the way we use energy across electricity, heat and transport,” Kent said.
He added that the country therefore has a significant need for new infrastructure development.
“This does, however, require supportive government policy; and we consider that the UK government and the private sector need to develop new models of working together to enable the financing of this infrastructure need to be realised,” said Kent.
He shared Morton’s positive outlook for the sector, adding, “given its importance, infrastructure usually benefits from government support, whether this is revenue support (such as renewable subsidies or an availability-based payment), capital support (i.e. support for the upfront costs) and/or a more bespoke support package,” he said. “All this supports the investment case.”
GCP Infrastructure’s Kent nonetheless acknowledged some areas of potential concern.
“We consider there are four main areas of risk associated with direct infrastructure investments,” he said.
One, he said, is market risks, where an asset is exposed to changes in market prices such as electricity prices or inflation.
Credit risks are the next areas of potential headache he mentioned, recognising that often an infrastructure asset relies on third parties to monetise that asset and therefore the value of the asset is reliant on the ongoing performance of these services.
Another potential worry, Kent said, was operational risk, which acknowledges that infrastructure involves real assets which have varying levels of complexity to operating and maintaining.
Last, but not least, are political risks, where assets are exposed to changes in the regulatory environment in which they operate. Infrastructure covers a wide range of asset classes – from wind farms to toll roads to airports, and the balance of these risks in each case is very different and needs to be understood.
Performance of trust vs sector since launch
Source: FE Analytics
The GCP manager also addressed the paradox of ethical investors not being keen on infrastructure. Given its importance in supporting economic output and essential services, he said, infrastructure should be an attractive asset class for ethical investors.
“Whether this is the generation of renewable electricity, faster journey times, or improved healthcare facilities, new infrastructure has clear and direct benefits to its users,” he said. “As well as this, infrastructure has indirect benefits in creating jobs as part of the supply chain for constructing and operating infrastructure, and promoting associated development.”