Infrastructure provides basic services essential for communities to function and for economies to prosper and grow. From an investment point of view this equates to the publicly listed owners and operators of essential services (such as regulated utilities in gas, power and water); and user-pay assets (such as toll roads, airports, ports and rail, where a user pays for the service).
According to our definition of infrastructure, these attractive assets are characterised by:
- Monopolistic market positions, or ones with high barriers to entry.
- Returns underpinned by regulation or contract.
- A largely fixed operating cost base.
- High up-front capital costs and then very low ongoing maintenance spend.
- Inflation hedges within the business.
These characteristics together provide long-term, resilient and visible cash flows, which underpin a yield or potential yield for investors.
It is because of these characteristics that infrastructure is known as a “defensive asset class”, with generally lower volatility of earnings and higher yields than broader equities. It is these attributes that attract investors to the asset class.
However, listed infrastructure remains an equity and can be caught up in market volatility. We saw this very clearly in March 2020. This market volatility can present significant opportunities for investors to capitalise on the defensive fundamentals and long-term infrastructure thematic of structural growth; and 2021 is showing all signs of being such a year.
There are a number of reasons for this optimism.
COVID-19 vaccines have been developed and are being deployed
This is a great demonstration of human ingenuity in a crisis. Some of the world’s best and brightest medical research minds have been focused on developing a vaccine, and fortunately, these efforts have borne fruit.
Huge fiscal and monetary stimulus will continue to propel global economic growth
While the currently worsening pandemic will last longer than initially hoped, the global economy will ultimately emerge stronger for the experience. The huge amount of fiscal and monetary stimulus is still to be fully felt in economic terms. For instance, in December US lawmakers agreed to a US$900 billion package of pandemic aid; in Japan a stimulus package of over US$700 billion was approved; and the ECB also boosted the size of its stimulus package and increased its bond-buying program by €500 billion (now at €1.8 trillion), taking total monetary stimulus in 2020 to over €3 trillion. On the fiscal side, the stimulus package totals ~€1.8 trillion, consisting of both the €1.1 billion EU budget and €750 billion Next Generation EU recovery fund. And more is to come, with governments globally still working on new and improved packages.
A substantial percentage of this fiscal spending is focused on infrastructure reinvestment and replacement. Industry participants suggest that for every $1 of infrastructure investment, an economy gets a boost of anywhere between $3 and $5. That’s a significant economic boost as a result of the infrastructure investment dynamic.
A positive for the listed infrastructure sector
Increased public sector infrastructure spending is a clear positive for the listed infrastructure sector. It boosts economic growth and labour efficiency, which is good for all businesses but especially those infrastructure businesses which form the “arteries” of an economy. It creates potential new opportunities for the private sector to co-invest alongside government or invest in place of governments. On a longer-term basis, it potentially provides a bigger pool of privatisation candidates.
A more stable, traditional form of US governance
The November 2020 election of Democrat Joe Biden as US President should herald a more “traditional” form of presidency, with properly developed and articulated policy returning as the mainstay of political discussion and debate.
One of the few policy areas Democrats and Republicans do agree on is the need for large-scale US infrastructure spend to both stimulate growth and replace an aged asset base.
Interest rates lower for longer
Of all the equity market sectors, infrastructure is one of the most closely correlated to movements in market interest rates. At present we look to be in a lower-for-longer scenario. While a low-interest-rate environment will benefit all equity asset sectors, it will be particularly beneficial to infrastructure. In the current environment, with record low-interest rates, we expect infrastructure companies to continue to take advantage of this historic scenario of low-interest rate long-dated debt.
This is not to say we don’t expect inflation to gradually return – we want it to. Given the quantum of stimulus yet to flow through into the real economy, coupled with huge pent-up consumption demand reflected in deposit rates that have spiked through the pandemic, we do expect inflation will come back. While we will be monitoring this closely, we are currently in the camp of a gradual return of inflation with it continuing to track below target levels through 2021. As such, we don’t see central banks being forced into any drastic action such as near-term interest rate hikes. We are also of the belief that central banks will let inflation run a bit ahead of target over the short to medium-term to assist in the reduction of headline government debt levels. However, it is worth reiterating that inflation can be positive for infrastructure assets and, in particular, the recovery names in the user-pay space (see further discussion below). In an inflationary environment these assets will enjoy the perfect storm over the short/medium term – namely low-interest rates to support future growth, economic activity flowing through to volumes, and explicit inflation hedges through their tariff mechanisms to combat any inflationary pop we may experience.
Long-term structural opportunity remains intact
Infrastructure offers defensiveness with economic diversity. These attributes, coupled with a significant growth pipeline, create a very attractive long-term thematic for the sector despite the near-term concerns of COVID-19. There is a huge and growing need for infrastructure investment globally, as a result of decades of underspend and the changing dynamics of the global population.
Replacement infrastructure spend
There has been a chronic underspend on critical infrastructure in virtually every nation over the past 30 years, if not longer. This has largely been due to governments having other spending priorities. For example, during the GFC the priority was saving the global banking system – not replacing water mains. During COVID-19 governments have prioritised social support – not road repairs.
Population growth
The second driver of the need for infrastructure investment is population growth. In 1900 the global population was approximately 1.65 billion people. By 2000 that number had grown to almost 6.1 billion – keeping in mind that some of the infrastructure we are still using today was built to service that 1.65 billion. By the turn of the next century, the global population is expected to be over 11 billion, underpinning the need for yet more spend. As a society we need to first play catch-up, and then invest for future generations.
Demographic trends
Longer-term global demographic trends further support the infrastructure asset class and the need for investment. The emergence of the middle class, particularly in emerging markets (EMs), is a theme that will provide enormous opportunity for investors.
When you combine all these factors – developed market replacement spend, population growth (largely driven by the EMs), environmental considerations and the emergence of the middle class in EMs – the long-term global infrastructure investment thematic is clear
It is also clear that governments, the traditional providers of infrastructure, are simply not going to be able to fully fund this need. This creates a huge investment opportunity for the private sector over the coming years.
That opportunity is a key thematic to which investors can gain exposure, and a thematic not derailed by COVID-19 – in fact, it is in all likelihood enhanced.
Meanwhile, solid well-managed infrastructure companies are in robust financial positions. Management teams have been taking advantage of open credit markets and low market interest rates to secure attractive, long-dated debt financing to ensure ongoing liquidity and support growth profiles.
We believe the combination of attractive investment fundamentals, long-term structural thematics that remain intact, the COVID-19 response and currently very attractive stock prices represents a unique buying opportunity for listed infrastructure – an opportunity we are looking to capitalise on as we move into the economic recovery phase and a hopefully prosperous 2021.
Sarah Shaw, chief investment officer, 4D Infrastructure
