Listed infrastructure: Missed opportunities
The listed infrastructure sector encompasses $2.5trn of global assets. So, asks Fraser Hughes, why would institutional investors focus exclusively on private infrastructure?
Over the past 10 years, infrastructure investment has gained momentum among institutional investors. But, to a certain extent, infrastructure investment has hit a crossroads.
From one side, the global economy is crying out for more infrastructure investment, but governments still own much of their economic infrastructure directly and are struggling to grow the pipeline of investable infrastructure assets. On the other side, ever more investors are competing for exposure to a relatively small pool of non-government-owned core infrastructure assets. This has seen transaction multiples increase strongly over the past 10 years. There is a clear supply and demand imbalance.
Investors typically allocate funds to infrastructure on its defensive characteristics and inflation-linked cash flow. The demand-supply imbalance means that asset managers have found it increasingly difficult to deploy capital. The latest figures estimate that $173bn (€175bn) of dry powder, is waiting to be invested in unlisted, or private, infrastructure. Exacerbating this capital backlog is scarcity of core infrastructure assets in the direct market and high multiples.
Given the current challenges of building an unlisted infrastructure exposure efficiently, we would expect that any current allocations to infrastructure are likely to take some time to be deployed. In the period during which allocated capital is not invested in the desired infrastructure assets, it may even be invested elsewhere in an institution’s liquid assets portfolio, most likely in equities, cash and bonds.
The $2.5trn listed infrastructure market, as defined by the GLIO Coverage, provides investors with a complementary, or alternative investment opportunity, which could provide a significantly better fit to their desired infrastructure exposure. This could be a long-term investment as an alternative to investing directly, or a shorter-term location to park capital until funds are drawn down to invest directly.
Listed infrastructure companies tend to own long-lived assets that provide essential services to society, such as utilities, energy transportation networks, communications and transportation infrastructure. These assets can offer stable and predictable cash flows supported by long-term contracts or regulation, with monopolistic characteristics and high barriers to entry. The GLIO Coverage has shown that the asset class exhibits compelling investment characteristics over the short, medium and long term.
Speaking at the annual EDHEC-infra Days Conference in June, Frederic Blanc-Brude suggested that a diversified portfolio should be in the region of several hundreds of assets, although he conceded that this is difficult to achieve directly. Blanc-Brude believed this could present opportunities for the funds-of-fund industry if they can get the fees ‘right’.
We would agree with this opinion and argue that listed infrastructure is another complementary route. Providing asset owners have a long-term investment outlook, the companies in the GLIO Coverage offer an excellent route to access in demand, good-quality, well-managed infrastructure assets. Listed infrastructure companies o ffer access to a broad, diversified portfolio of assets in the Americas, EMEA and Asia-Pacific.
These will include both developed markets ($2.4trn) and emerging markets ($100bn). In the GLIO Coverage (based on country of primary listing) the US, Canada, Japan, Spain, Italy, Hong Kong and the UK are heavily represented. This breakdown can be slightly misleading, as most listed infrastructure companies own and operate numerous infrastructure assets located in a number of countries beyond their location of listing – Hong Kong/China being the prime example.
Infrastructure assets tend to fall under four main headline sectors.
• Utilities: Electric distribution, electric transmission lines, gas distribution pipelines, renewable energy facilities, water cleaning and distribution systems;
• Energy transportation and storage: Long-haul energy pipelines, gathering and processing facilities, liquid terminals and LNG facilities;
• Transportation: Airports, seaports, railroads, highways and toll-roads;
• Communications infrastructure: telecommunication infrastructure (wireless macro towers and small cells) and satellites.
It is worth noting that global listed infrastructure can access a broad set of investment opportunities across geographies and sectors, which by comparison might not be available through direct investment. It is also worth noting that although the listed infrastructure market is large, some assets cannot be accessed – US airports are a good example. Regulatory frameworks and contract structures vary greatly by country and sector. Diversification can help mitigate risk in concentrated exposure to regional economic conditions and regulations.
Historically, global listed infrastructure has offered an attractive income component as a portion of the overall total returns. The asset class has offered higher yields compared with global equities over the long term. On average, since 2003, global listed infrastructure yielded about 3.6% versus 2.6% for global equities. Global utilities averaged 4.1% over the same period. These dividends are underpinned by higher sustainable cash yields that provide companies with the opportunity to raise payout ratios. This is particularly evident among the transportation-focused companies such as freight rail, highways and toll-roads.
Infrastructure assets with the same economic exposures will respond similarly to changes in the economic environment. However, the types of vehicle in which these assets are held can be valued using different methods. Unlisted infrastructure values are based on periodic valuations that lag current market conditions and are inherently smoothed, or even suffer from auto-correlation. Listed company valuations are subject to daily pricing and are more volatile over the short term. Of course, this can create opportunities for active global listed infrastructure managers.
Putting aside short-term differences in valuation, GLIO research highlights the fact that over the medium to long term, listed infrastructure offers the very similar performance as unlisted infrastructure, and vice-versa. Many would argue listed infrastructure can act as an excellent proxy for direct/unlisted infrastructure.
Another method to compare the unlisted and listed infrastructure valuations is to use EV/EBITDA multiples. In this example we look at the global airports sector over a 12-year period. The blue circles represent individual airport asset deals. The blue line represents the average EV/EBITDA ratio of the listed airport sector. Many of the listed airports own some of the world’s best performing assets in terms of passenger volumes and customer experience/quality.
It is clear from the example, listed airports offer ‘better value for money’ compared with transacting individual airport assets. The question of asset diversification and management quality and experience can also be raised here.
Impressively, the GLIO Coverage has exhibited similar average total returns to unlisted infrastructure over the long term while offering ‘defensiveness’ or ‘downside protection’ during equity market sell-offs. Using quarterly data, to reflect the frequency of unlisted performance dissemination, we compare listed/unlisted infrastructure versus global equities. On average, quarterly total returns for listed (+3.2%) and unlisted infrastructure (+3%) are similar. Global equities (+2.5%) lag-behind.
Interestingly, during the 2008 crisis, listed and unlisted infrastructure lost and recovered at the same rate (36 months) – global equities took 66 months to recover.
When global equities record a positive quarter, the GLIO Coverage captures 93% of the upside. Moreover, during quarters where equities are negative, the GLIO Coverage only ‘captures’ 48% of the downside. In other words, 52% downside protection.
Listed AUM on the up
Global listed infrastructure is a relatively new asset class, but it can deliver significant benefits to broader, multi-asset portfolios and targeted infrastructure allocations. The asset class also lends itself to active management.
Figure 6 shows the impressive growth in assets under management over that period. Looking head, as the challenges of building an allocation to direct infrastructure intensify, more investors will look to listed infrastructure as an alternative route to deploy capital into the quality core infrastructure assets they crave. Ten years from now this total AUM could easily pass $300bn.
The need for infrastructure investment is a never-ending cycle. Governments will need to offer incentives for infrastructure investment to provide the backbone to boost economic growth. The poor state of US infrastructure is well documented. The latest American Society of Civil Engineers (ASCE) scorecard makes depressing reading. The overall grade for US infrastructure was D+.
The story is similar across the globe as the percentage of infrastructure investment relative to GDP has declined over recent decades. Subsequently, the infrastructure investment gap has widened, with an estimated shortfall of $15trn to 2040, according to GI Hub.
Infrastructure investment vehicles will need to develop and evolve to help address this critical issue. In recent years the US has seen Yieldcos, MLPs and REITs offer investors exposure to infrastructure with a focus on income. Belgium has expanded its REIT structure to include infrastructure, India introduced an Infrastructure Trust, and Mexico introduced the FIBRA-E. The opportunity to create a clearly defined Infrastructure Investment Trust (IIT) for economic critical infrastructure could look attractive for governments wishing to attract both domestic and international capital to fill the investment gap.
Listed infrastructure is a compelling way to gain exposure growing part of the global economy, combining the attributes of direct infrastructure investments coupled with the benefits of listed markets: broad global $2.5trn market, liquidity, and transparency.
Ultimately, a carefully defined, core listed infrastructure market is made up of a large number of high-quality infrastructure assets, covering regulated utilities, energy transportation, transportation and communication infrastructure. These assets are mission-critical to the needs of the global economy.
We should not forget that most institutions would gladly include these assets within their direct infrastructure portfolios if they were available in unlisted form, so why view them differently them because they are listed?
The companies in the GLIO Coverage have demonstrated desirable investment characteristics over many years and can play a valuable long-term strategic and tactical role within an institution’s broader infrastructure allocation.
Investors who ignore the global listed infrastructure asset class narrow their core infrastructure options considerably, which could in turn damage stakeholder returns.