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What role can infrastructure play in a portfolio?

12 August 2019

Steven Kempler

Portfolio Manager B. Comm, LLB, M Fin CFA Steven has 12 years infrastructure investment experience. Steven is an airports expert and also the analyst responsible for coverage of communication infrastructure assets and emerging markets infrastructure.

THIS ARTICLE IS AN EXCERPT FROM A RECENTLY RELEASED RESEARCH PAPER “THE ROLE OF INFRASTRUCTURE IN A PORTFOLIO.” PLEASE EMAIL invest@maple-brownabbott.com.au IF YOU WOULD LIKE A COPY OF THE FULL PAPER.

Our view is that investors seek to benefit from the essential service nature and strong strategic positions of infrastructure assets. Such investors also look for inflation protection and more stable income relative to certain other asset classes such as global equities and global REITs. The growing global interest in infrastructure has been supported by a historically lower volatility and a less than perfect correlation with global equities. We have previously analysed the role of infrastructure in a portfolio including capital preservation, downside protection during market weakness, reduced correlations with other assets, and a long-term inflation-linked growth in income. In this latest report, we review whether these attributes still hold true.

What are investors looking for in an infrastructure investment?

Generally, in our experience we have seen investors look to infrastructure assets to deliver lower cash flow volatility and higher earnings stability compared with broader global equities. We have also seen investors target the asset class for its historically higher income as well as the perceived inflation-linked growth of that income – both attributes with which we agree.

Infrastructure assets typically have strong strategic positions by being natural monopolies. These monopolies are the physical networks and structures that provide services essential to the basic functioning of society and its economic productivity. Ultimately, it is the commercial frameworks that underpin these assets that result in what we see as attractive investment characteristics.

What does the empirical evidence show?

To many asset allocators, infrastructure is often referred to as a “diversifier” in a portfolio. The cash flows being generated by infrastructure assets are supported by very different commercial frameworks than the typical company within a global equities basket. Most infrastructure assets have their earnings or revenues linked to contracts or concessions with built-in inflation escalators, or have returns set based on a regulated asset base with limited or no link to volumes or cyclical demand. Many regulated environments offer return formulae that allow the ability for an asset to earn a target return, regardless of market conditions and often detached from the economic cycle. This results in the cash flows and value of infrastructure behaving differently to general equities in both up and down markets, resulting in reduced correlations.

Whether an investor chooses to invest in global infrastructure for its downside protection, for its reduced correlations with global equities, or for its inflation-linked income, a thought should be given to return expectations. While past performance is never indicative of future returns, as seen in Figure 2, the absolute real return generated by the asset class over the long term shouldn’t be ignored.

Steep sell-offs are where the asset class shows its stripes

The large market correction in late 2018 is worth highlighting. During this period global equities were down 18% in USD terms, whilst global infrastructure was down only 6%. Whilst there is, and always will be, an element of equity market beta embedded in global infrastructure, as can be seen in Figure 3 the differential in drawdowns is not unique or isolated to this single event.

1. Unless specified otherwise, data referring to Global Infrastructure is based on the returns of the FTSE Global Core Infrastructure 50/50 Index, which was launched on 2 March 2015, although FTSE have back filled the history of the index back to 31 December 2005. We believe that the FTSE Global Core Infrastructure 50/50 Index is the most appropriate index to use in this context due to its constituents exhibiting infrastructure “purity” characteristics and strong inflation-linkage compared with other indices.

This update was prepared by Maple-Brown Abbott Limited (MBA) ABN 73 001 208 564, Australian Financial Service Licence No. (AFSL) 237296. This update is confidential and the recipient agrees not to release or reveal it to any third party. It is not an advertisement and is not intended for retail investors (as defined by section 761G of the Corporations Act, 2001 (Cth). This paper is general information and commentary only, and is neither an offer to sell nor a solicitation to buy any securities or funds and should not be considered as such. This update does not have regard to an investor’s investment objectives, financial situation or needs. Independent professional advice should be sought in respect of individual circumstances.

Information in this paper is derived from sources believed to be accurate at the dates noted, however information from third parties has not been independently verified. Such information (including any forward looking statements) may be subject to assumptions and qualifications compiled by the relevant source and this paper does not purport to provide a complete description of all or any such assumptions and qualifications. MBA does not warrant that information in this document is accurate, reliable, free from error or omission and, subject to the law, does not accept any responsibility for errors in, or omissions from, the information. MBA does not make any representation or give any guarantee as to the future performance or success of, the rate of income or capital return from, the recovery of money invested in, or the income tax or other taxation consequences of, any investment which by its nature is subject to risks including fluctuating prices, uncertainty of dividends, rates of returns and yield, including the possible loss of the amount invested.