The global listed infrastructure markets offer investors the ability to invest across sectors and in a straightforward, transparent and cost-efficient way. Susan Dambekaln and Michael Underhill explain
Unsettled economic times send many investors seeking sanctuary. The current climate is such a time, making assets such as global listed infrastructure securities attractive.
Simply defined, infrastructure assets are a broad mix of a country or region's large-scale public systems, services and facilities necessary to economic activity. The sector includes power generation and transmission, water supplies and wastewater treatment, public transportation, rail, roads, bridges, tunnels, ports, airports, telecommunications and basic services such as schools and hospitals. With the market value of outstanding listed infrastructure securities at roughly $1.79trn (€1.29trn), according to ‘S&P Listed Infrastructure Assets - A Primer 2011', this sector has emerged as a distinct asset class.
Infrastructure assets provide a necessary service to society and tend to have a monopolistic position in their market, with high barriers to entry for competitors. They therefore tend to be highly regulated, which results in distinct investment opportunities.
Another characteristic of the sector is that it provides vital services requiring heavy investment. Infrastructure assets are therefore built to have long useful lives. Additionally, output demand from these assets tends to be inelastic because of the scarcity of the resource being offered. With the pricing power that results from their market position, the revenue growth from these assets is typically limited by regulators to the rate of inflation. These factors result in infrastructure investments being able to offer long-term stable cash flows that have the potential to help investors hedge against inflation.
Infrastructure investments also exhibit a hybrid nature, providing stable cash flows akin to those generated by fixed-income instruments, coupled with the potential for substantial capital gains resulting from improvements and increase in capacity. The best opportunities for capital gains come from investments involving development risk or monopoly businesses.
Additionally, infrastructure investments offer a variety of risk-and-return profiles ranging from low-risk regulated assets to moderate-risk loosely-regulated entities such as energy production.
The assets offer varying amounts of inflation protection and different levels of vulnerability to economic cycles. It is important to note that, while these assets are all considered to belong to the same asset class, not all will exhibit the same risk-and-return behaviour.
Global demographic trends are driving the need for new infrastructure in the world's developing economies. China and India, for example, need new infrastructure to support the urbanisation of their economies and growing populations.
In the developed markets, basic infrastructure is often old and dilapidated, having been built in the middle of the 20th century. The percentage of GDP that developed economies spend on infrastructure has been steadily declining for decades, leaving them with a crumbling legacy.
America's crumbling infrastructure has been well documented over the past few years. Yet funding levels, as a share of all federal expenditure, are exactly the same as they were more than 20 years ago. The American Society of Civil Engineers estimates that US infrastructure funding needs are $2.2trn over a five-year period.
Over the years, the US government has pushed the responsibility for the growth and upkeep of the country's infrastructure down to state level. However, the states have found it difficult to raise the money required. More recently, the economic downturn has reduced the usual sources of revenue for the states. Property taxes, income taxes and sales taxes have all declined precisely when the need for capital is the greatest.
At a crossroads
With US states unable to incur a budget deficit from year to year, they are unable to generate the capital for essential improvements to infrastructure. The US states are at a crossroads and many are beginning to court private investors to fill their budget gaps.
Recently, the commitment in the US to spend more on infrastructure projects has stimulated modest job creation. In addition to the long-term trends that are benefiting this asset class, the stimulus package recently enacted by the US government will benefit this sector directly in the near term.
A recent survey conducted by the Capital Innovations Institute in September 2011 found that, when making their investment decisions, investors look at: diversification; liquidity; reasonable fees; valuation and daily market pricing; transparent corporate governance; active management, and value creation.
Global listed infrastructure can provide these attributes to investors in a framework that can be straightforward and easy to understand, differentiating it from many other complex, unlisted (private equity-type) investments.
• Diversification: There are risk and return elements to any investment strategy. Listed infrastructure securities enable investors to diversify across sectors, which might help to alleviate some of the inherent risks present, including regulatory risk, demand risk, interest rate and refinancing risk. Diversification across regulatory sectors, physical assets, currency exposure and political risks (country or regions) helps investors construct a portfolio that achieves their desired risk-return profile. This can be achieved in a global diversified portfolio of holdings;
• Large investment universe that provides liquidity: Investors may access investment vehicles, separately managed accounts and mutual funds, all of which have liquidity that is not available in direct project finance deals. This liquidity feature allows investors to put money to work easily and conversely trim their listed infrastructure exposure to maintain their asset allocation models;
• Reasonable fees: Fees are typically higher in private infrastructure transactions. An actively-managed portfolio of listed infrastructure investments at institutional pricing can be more attractive than buying the benchmark and paying active management fees;
• Valuation and daily market pricing: Unlisted infrastructure valuations are performed by an independent auditor or administrator. Listed securities are traded on exchanges, providing investors with the transparency they need;
• Transparent governance: Listed companies are subject to scrutiny by regulatory authorities, governments, investor advocacy groups such as UNPRI/UN Global Compact, labour unions and the media. There is increased focus by these companies on social issues, the environment and governance.
Finally, there is active management. The value proposition behind active investments in a portfolio of listed infrastructure securities can be seen by examining the composition of the frequently-used benchmarks. The Macquarie Global Infrastructure Benchmark is almost entirely comprised of global listed utilities companies (approximately 90%). The S&P Global Infrastructure Benchmark is more diversified, comprising utilities (40%), transportation companies (40%) and energy companies (20%).
Active portfolio management in the listed infrastructure sector provides the ability to generate significant returns while avoiding unwanted sector concentration in the benchmark. Additionally, stockmarket volatility has risen, creating a greater dispersion of returns among individual stocks and expanding the scope for active managers to distinguish themselves from a benchmark. In short, global listed infrastructure securities are another ‘club in the golf bag', offering alternative access to a dynamic market opportunity.
Susan Dambekaln is founder and portfolio manager, and Michael Underhill is chief investment officer at Capital Innovations