Eyes turn to listed infrastructure

In June, amid rising inflation and soaring energy costs, the Spanish government announced that it was preparing a new tax on electricity utilities’ profits, which had been bolstered by high energy prices. 

For institutional investors who are allocating to listed infrastructure, these types of announcements bring the issue of regulatory risk into sharp focus. But fears about regulation have been tempered by the need for inflation protection and the search for defensive, performance-generating opportunities. The listed infrastructure asset class has grown 7% per year over the past 20 years. It now has a total market capitalisation of approximately US$4trn (€3.9trn) and is expected to continue to grow as investors search for safety. 

“We see a lot of investor demand,” says Jeremy Anagnos, CIO for listed infrastructure at CBRE Investment Management. “In a market environment where you have such unprecedented levels of macro forces and uncertainty – from high levels of inflation to aggressive central bank policy and the raising of interest rates to battle that inflation, on top of a war in Europe that’s causing a global energy crisis – investors are favouring listed infrastructure. These assets are far less sensitive to macro forces. The cashflow stability that is afforded because they are regulated or contracted for a long duration brings resiliency.”

Peter Meany, head of listed infrastructure at First Sentier Investors, also emphasises the inflationary protection characteristics. “Our analysis has found that more than 70% of assets owned by listed-infrastructure companies have effective means to pass through the impacts of inflation to customers, to the benefits of shareholders,” he says. “As a result, listed infrastructure has a track record of outperformance during periods of higher inflation.” 

Global infrastructure stocks generated a total return of 15.7% in 2021, as measured by the FTSE Developed Core Infrastructure 50/50 index. Over the medium term, listed infrastructure has delivered strong risk-adjusted returns compared with equities, according to data compiled by consultancy bfinance in its report, Re-evaluating the Case for Listed Infrastructure. Based on 15 years of data, various listed infrastructure indices have outperformed the MSCI World index in achieving higher annualised return (8.5-9.4%) with lower annualised standard deviation (11.6-13.8%).

“One of the hallmarks of the asset class is that it tends to outperform in periods of unexpected inflation, because of pricing mechanisms that are embedded that allow [companies] to increase tariffs or fees in context to inflation,” says Benjamin Morton, head of global infrastructure for Cohen & Steers.

Another driver of growth is the accumulation of dry powder in the private markets, according to Morton. “Private infrastructure capital is being raised all around the world, and over $350bn of that is dry powder that needs to be invested in infrastructure assets. Because competition has become very fierce on the private side, with only a finite number of assets that present themselves at any one point of time, more and more of that money is finding its way to the listed market. Private infrastructure vehicles are buying assets, stakes in assets or entire companies from the listed infrastructure universe,” says Morton.

He points out that the transactions typically happen at significantly higher multiples than traditionally seen in the listed sector, providing a strong valuation floor while also allowing companies to finance at lower costs of capital than issuing common equity.

As private infrastructure valuations soared in the decade that followed the global financial crisis, the listed space became a focus point for cheaper entry, according to bfinance. The firm notes that listed infrastructure assets could still be seen as attractively priced versus unlisted counterparts. On average, 80% of illiquid infrastructure deals were struck above listed multiples; direct investors having paid a premium of 40% when compared with the GLIO index. Overall, suggests bfinance, there is a healthy correlation between returns for listed and unlisted infrastructure. 

Investors are also turning to the listed market because accessing private infrastructure takes a long time, and liquidity becomes a concern, suggests Anagnos. “It’s not a transaction that happens every year or couple of years,” he says. “There are long queues to deploy capital and get into some of the funds. So if a large investor already has an allocation [to private infrastructure], it is a way to timely increase allocation. It is also a way to tactically take advantage of a dislocation of pricing.” 

Investors are accessing the asset class in different ways. Emily Foshag, portfolio manager at Principal Real Estate, believes that listed infrastructure can make sense as a component of a variety of different buckets of allocations for institutions. “They can be used as part of a broader infrastructure allocation, as a complementary way to access similar assets to what is available in the private markets,” she says. “Some of the listed infrastructure offerings may not be available in private markets, and vice versa.” 

For example, to invest in Australian airports at the moment, investors must do so via the private markets. But in the case of Spanish airports, they need to look to the public markets, Foshag suggests.

Moreover, some sub-sectors are more accessible in the listed arena. “Private market allocations are increasingly on brownfield – also known as operational infrastructure – assets,” she says. “So if you want to talk about renewable energy developments or other technological developments that support the energy transition, that is now mostly in the purview of listed infrastructure.”

Industry participants are quick to point out that the energy transition of the global economy will add further momentum. “The energy transition is a mega trend,” says Jags Walia, portfolio manager for listed infrastructure at Van Lanschot Kempen. “It took 130 years to build the existing network of power generation – and for the Paris Climate Agreement we need to flip that all on its head by 2050. All the investment we made over the past 130 years, we now have to squeeze into the coming 28 years. That’s driving cashflow visibility.”

Foshag points out that the carbon intensity of infrastructure companies is higher than broader global equities indices. “Listed infrastructure is less than 5% of the MSCI World index but represents a quarter of scope 1 carbon emissions. Some investors have taken the view that they should just divest. We are of the mindset that if you want to have real impact on the real world, then you have to be willing to engage with these companies and understand the challenges that these businesses have as they are embarking on their journeys through the energy transition,” she argues.

Another key structural driver is digitalisation. Meany believes that structural growth in demand for wireless data is supporting steady earnings growth from towers and data centres, insulating them from the movements of the broader economy. “The changes required during the pandemic have already led to a greater reliance on wireless data in many people’s everyday lives,” he says. “The adoption of 5G technology over the medium term will require networks to handle increased data speed, and a much higher number of connected devices.” 

Still, industry participants acknowledge that regulatory risk is something investors will have to accept. “The key risk for infrastructure investors remains political or regulatory uncertainty or intervention,” says Meany. “Most infrastructure assets operate from privileged positions, providing an essential service with limited competition. As a result, infrastructure companies often earn regulated returns, and are likely to face a higher level of public scrutiny.”

Morton says: “The biggest risk in this asset class is clearly day-to-day regulatory risk. But this also presents opportunities. We look for dislocation where [the] market is under-pricing or over-pricing regulatory risk. For example, we may decide that a proposed utility rate increase will result in a more favourable outcome than the consensus expects.” 

Foshag highlights the importance of diversification. “The changes or risks that lead to sharp drawdowns in listed infrastructure are often very difficult to predict,” she says. “We think we’re good at our jobs, but there is a role for portfolio construction, and for us philosophically we do think it’s important to manage security-level position sizing.”

Anagnos agrees: “Infrastructure plays an important part as a diversifier to your portfolio and should have a differentiated risk-and-return profile. It is important that investors consider getting exposure to the full asset class. Some of the indices have passive options and no exposure to the communications sector or digital assets, or to renewable energy companies. We think it is better to get exposure to the full complement.”