Welcome to Finance and Fury. This episode will looking at infrastructure as an asset class, to see if it can help to provide some diversification for portfolios and decent moving forward.
- Infrastructure – physical assets that provide services that are essential for us to live our lives. The aim is to invest in assets that if the market booms or busts, it provides some diversification to traditional asset classes.
- Traditional Asset classes –
- Defensive – Cash, Fixed interest (gov, corporate bonds, credit)
- Growth – Property, Shares – Australian or international
- Where does infrastructure sit – still in the growth category – In my view – can help to provide a real asset can play a role in an investment portfolio – two component for reasons to invest in infrastructure
- Diversification – infrastructure allows an investment in lower correlation to other asset classes – however, depending on the type on investment purchased, some may have “higher beta and therefore less diversifying”
- Real use – value – investment in areas that we generally interact with these essential services every single day, gas, water, electricity, transport
- Traditional infrastructure
- Transport – seaports, airports, major roads, bridges, tunnels
- Utilities – Power generation, energy distribution and storage, water, sewage
- Renewable energy – big asset class moving forward
- Communication – network towers, satellites, phone networks
- Infrastructure at the moment is potentially undervalued due to not seeing the same rebound as many other growth investments over the past 6 months – oil prices also went down – the year returns haven’t been great –
- effects are cyclical – there may be an opportunity today from a pricing perspective – the market has marked down real assets and infrastructure at the moment –
- Lot of money being spent on infrastructure – there is a major need in developed economies for revamping of aging infrastructure, and for new infrastructure projects
- In addition – emerging markets which have their economies growing as well as their population’s wealth increasing, the demand for more and better infrastructure continues to rise
- But government budget pressures have been affecting their ability and willingness to fund infrastructure projects, creating more opportunities for private capital in the asset class – however, with the invention of green bonds as well as cash rates for funding being close to zero, this could increase the amount of money available to fund projects
- Predictability of cashflow – Infrastructure assets usually have a pretty high level of visibility and security when it comes to their future cash flows.
- When talking to fund managers, they say that they look for projects that almost have guaranteed revenues – those that are underpinned by regulation or long-term contracts with highly creditworthy counterparties – such as governments – compare this to other companies where their cashflows are not as secure – the valuations can be hard
- However – most infrastructure could be considered to be a Public Private Partnerships – where the public sector partners with a private sector company – The private sector company develops, constructs, finances, operates and maintains the infrastructure, and the public sector pays for those services -the concessions for the assets are often granted over lengthy contractual periods, which can be over 30 years – so the cashflows can be relatively secure
- Also – they have Inflation-linked revenues – The revenues that infrastructure assets earn are often linked to inflation – rates of return set by regulators frequently linked to future inflation expectations in in a long-term contract.
- A competitive advantage – A lot of the time, infrastructure assets have a form of a monopoly in the services that they provide – or in other cases, they operate in markets with high barriers to entry
- Therefore, the assets cannot be easily replicated and often remain free of the competitive pressures confronting more traditional organisations – so again, the risks that an established project all of a sudden has a new up coming competition are very low – helping to reduce uncertainty risks
- The Essential nature of infrastructure and correlation –
- People tend to use these essential services on a daily basis and that utilisation (and returns) can often depend less on the economic climate at a point in time than other investments – Because of that essential character, economic factors often have less of an influence on infrastructure assets than on numerous other businesses, which can assist in delivering stable returns through market cycles
- infrastructure as an asset class, particularly unlisted infrastructure, has historically demonstrated low levels of correlation with other growth asset classes – can help to reduce volatility of a portfolio
The risks of infrastructure
- Too much leverage and interest rates
- Debt and the cost of that debt can be a big factor in the future performance of a project –
- Technically – with interest low or falling – the cost of debt declines – this means the costs of capital also decline in the valuation of projects –
- This means that the values of the project increase – but the opposite is true, if interest rates rise, then the valuations can also decline
- on average, most infrastructure stocks have higher debt to equity or gearing levels than the average stock and therefore are more vulnerable to interest rate rises.
- Debt and the cost of that debt can be a big factor in the future performance of a project –
- Greenfield risk – this is a major risk for new projects – where the estimates don’t stack up to reality – an example of this would be a toll road at the beginning of its life, when it has the most uncertainty – what traffic levels of the road will really be like remains to be seen. Tolls may have been set, but again, sufficient usage of the new road is essential – there can be too much uncertainty which can be dangerous
- You can also have Construction risks, delay risks and cost blowouts – Example – The Queensland Government contracted BrisConnections to run its Airportlink Project, which opened to the public in 2012. Initial forecasts were for the 6.7km tunnel, linking Brisbane Airport with the CBD, to carry 170,000 vehicles per day. Six months after opening, there were only 50,000 vehicles using the road and BrisConnections went into receivership. The roadway was eventually sold for $2 billion to Transurban, despite having cost $4.8 billion to construct. Many retail investors who invested in the initial public offer at $1.00 lost most of their money when the shares plunged to $0.001 within months. Further, the shares were structured as instalment warrants carrying a further two instalments of $1 each. People who thought they were being canny traders, picking up a bargain, suddenly found that for each $1,000 they invested, they incurred a $2 million liability.
- Lesson – investing in early infrastructure projects is very risky – especially if there aren’t government guarantees on the returns
- Management and ESG factors – while real assets like infrastructure can be fairly low risk, this can be negated by the people that run them – the same with any company
- When looking at infrastructure businesses – It might be the case that too much risk is taken on, a white elephant is built, or the capital structure is not right and there is too much leverage. The human element is very important to assess as the humans are the ones making the decisions on what to build based around assumptions – if enough mis management occurs, a company can lose its licence to operate an infrastructure asset if the asset is not well managed.
- In Italy – Autostrade is a company that controls the roads forming the Italian system of motorways – currently at risk of having its motorway concessions revoked because of the collapse of a 200-metre section of a bridge in the city of Genoa in August 2018
- Currency risk – When investing in global infrastructure assets, currency risk is introduced into the equation and
- This can affect the returns of an investment due to changes in currency exchange rates
Infrastructure performance – infrastructure has done well over the years depending on the sectors invested in
- Pretty strong returns have been achieved by a blended allocation of property and infrastructure
- International infrastructure fund – 10.32% over 10 years – invested for 7 years with a return of about 9% – off the back of a 1-year return of -16.41%
- Over the same timeframe – ASX index – 7.66% return for 10 years, but the 1 year returns are only negative 2.6%
- Obviously past performance isn’t an indicator of future performance
- Looking forward for returns – Comes from demand factors – who is going to use the assets? And will they actually be used. With this in mind:
- should concentrate on owning infrastructure in high population growth areas – does not make sense to add infrastructure in regions where there are less customers each year because populations are going backwards – an example would be Japan – a toll road project where there is no pricing power because it is difficult to raise tolls in this situation.
- The best infrastructure plays are those where there is exposure to high population areas and urbanisation – happening in many developing countries
- Important to research the investments if you are considering it – as some managers do have big weightings to Europe, with regions with less population growth – but some of them have the cash cow of governments funding these projects
Investing in infrastructure – Accessing infrastructure – your options – this is not advice but the general methods to access it
- Listed – This is purchasing shares that are listed that deal in infrastructure – an example would be Transurban or Sydney Airport
- Another option is to purchase managed funds that deal with infrastructure – I have a mix of both – international I do through managed funds
- Unlisted – this is a little harder to get
- The risks here are similar to property trusts – illiquid nature
- The correlation question – listed infrastructure can be heavily correlated to the equity market – makes sense as it is listed on the equity market
- However – it does provide some measure of diversification – different shares in different sectors –
- But when the market falls – all shares take a ride down
- Infrastructure investment offers the opportunity to invest funds into assets that play an integral role in daily life – when looking at investments for the long term – confidence is important – what are people still going to be using and demanding as a product in 10 to 15 years? Then, what companies are in a position to be providing these above competitors
- The benefits of infrastructure investments are predictability of cash flows, the longevity of assets, and comparatively less volatility of a portfolio overall than going purely into Australian shares
- There are also risks associated with infrastructure investments however – might involve higher debt to equity or gearing levels compared to other assets, ESG factors and with global infrastructure, currency risk that needs to be considered. Additionally, greenfield risks might deter some investors from investing in infrastructure projects at the start of their lives.
- As is true for all investments and strategies – you need to take careful consideration of if infrastructure is appropriate for you.
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