Commenting in Morningstar’s Global Listed Infrastructure Sector Wrap-Up, senior research analyst Tim Wong said the asset class appears particularly vulnerable to rising interest rates “at first glance”.
“A higher cost of capital shrinks the present value of the long-term cash flow that represents so much of these securities’ worth,” said Mr Wong.
The above-average gearing levels of listed infrastructure companies means there is a greater sensitivity to higher interest charges – particularly when refinancing debt, he said.
“Unprecedented low interest rates have prompted investors to bid up the value of risky assets in their search for yield, infrastructure included,” said Mr Wong.
But it is “natural” to believe the opposite could happen, given the sector’s valuations have increased “significantly” since 2009, he added.
“It was perhaps no surprise that all infrastructure strategies dipped in value when government bond yields jumped unexpectedly in mid-2013,” said Mr Wong.
Indeed, the role of global listed infrastructure in buffering a portfolio during down markets should be questioned as a result, he said.
“This isn’t likely to ease the nerves of investors jittery about the prospect of rising interest rates,” said Mr Wong.
But there are “shades of grey” to the relationship – and investors must distinguish between real yields and expected inflation.
“We’ve argued previously that there are logical, if not foolproof reasons the sector can handle rising inflationary pressures [given its] superior ability to pass on higher costs, relatively low variable input costs and the non-discretionary nature of essential services provided,” said Mr Wong.
In addition, differing time horizons within a portfolio can reduce the risk for investors, he said.
“Large swathes of the infrastructure sector are subject to different risks than most other equities, namely regulatory risk,” said Mr Wong.
As a result, many infrastructure assets are “relatively insensitive” to broader economic cycles, so the sector can also be used as a relatively defensive equity strategy, he said.
“Sharply higher interest rates” could spell periods where risky assets converge, but that is likely to be a short-term phenomenon," said Mr Wong.
“Timing mismatches between cash flow and interest rates can be reconciled eventually if there is a clear mechanism linking them.
“The traits that distinguish infrastructure from more economically sensitive equities should materialise over time and support its portfolio role,” he said.
