This article is sponsored by AMP Capital
What are you observing about the growth of listed infrastructure as an asset class, and how might it be a viable alternative to private infrastructure?
Similar to private infrastructure, listed infrastructure as an asset class has enjoyed significant growth over the last decade. When I joined AMP Capital in 2012, funds under management managed by investment professionals like ourselves stood at around $25 billion, and today that figure is roughly $110 billion. Part of that growth has been down to asset value appreciation, but it is also driven by inflows of capital into the asset class from investors pretty much worldwide.
This increase in investor appetite has been met by an increase in supply, because we are now starting to see a lot more asset managers and investment boutiques launching new funds.
A decade ago, there were questions about whether listed infrastructure was a separate asset class. It is now well understood as an asset class that can stand on its own and investors are using it to get exposure to infrastructure assets. Infrastructure assets are the same regardless of the capital structure – an airport is an airport, a gas pipeline is a gas pipeline.
Indeed, the total returns of listed infrastructure have been very consistent with private infrastructure funds in the last decade, with a high single-digit total return comprising 5 to 6 percent capital appreciation and 3 to 4 percent yield.
But there are differences between listed and private infrastructure, the attractions of which appeal to different investors. Listed infrastructure can provide liquidity and low transaction costs for those that wish to gain infrastructure exposure quickly, as well as diversification at both a sector and geographic level. You can also scoop up listed infrastructure at a discount to what you would pay in the private world, which explains public-to-private activity to arbitrage that differential.
On the private side, when you acquire an asset, you can have immediate control to enhance the value of the asset. The investment horizon tends to be much longer, and you don’t have daily mark-to-market basis, which is appealing to some investors, also because of regulatory reasons.
The two can prove complementary. Right now, we see the public market providing liquidity to private funds going through the J-curve of deployment of cash but also, once a portfolio is fully invested, the public markets can provide diversification into assets or regions that are under-represented. We are seeing more of those strategies and expect this to be a growing theme.
How has covid impacted the asset class?
To understand the impact of covid on listed infrastructure, it’s important to differentiate between sectors that are more cyclical, like energy and transportation, and those that are more defensive, like utilities and communications.
What we witnessed, particularly in the early stages of the pandemic, was a big impact in those more cyclical sectors and almost no impact in the defensive part of the market. That was driven by a contraction in the economic environment, which was not surprising, and also the compression in rates benefited the sectors within the asset class that are longer duration.
As we have gone through the pandemic, economies have started to adapt and we are now seeing a gradual recovery in valuations, even in the more GDP-sensitive areas. There is still some dislocation due to investor concerns around the path to exit from the pandemic, but that is reducing.
As an active manager, we have used our in-depth knowledge of the assets to understand dislocation between valuation and price. We have stayed disciplined to see how much of the drop in prices was down to fundamentals and how much was down to investors not being willing to value assets appropriately.
Can you explain the current pricing environment, and any impact you are seeing from rising inflation and an evolving interest rate environment?
Since 2020, and particularly in the last 12 months, we have seen the gradual recovery of infrastructure assets and a recovery in pricing, though in some GDP-sensitive sectors there are still pockets of mispricing.
Thinking about the investment universe, we expect the asset class to deliver around 9 to 10 percent total returns. The returns today, based on current pricing, are in line with historical trends. Also, the mix between capital appreciation and dividend payment should be consistent with the past. Of course, if you drill down into specific sectors there are variations, with energy and transportation showing higher expected returns than utilities and communications.
Clearly rising inflation has become a key topic. Our investment team forecasted in mid-2020 that the supply shock would inevitably result in inflationary pressure, so we were able to position our portfolio to benefit, which is why we were able to deliver strong returns for our clients last year. Inflation is almost a direct result of the initial covid demand shock followed by a supply chain adjustment. Supply is a lot more inelastic so you get inflation as demand bounces back quicker than supply can respond.
Infrastructure as an asset class is naturally geared towards an inflationary environment. Transportation and energy stocks supply a natural hedge; very often the cash flows of companies that we invest in are automatically linked to inflation.
In this case, rising inflation is the result of a robust economic environment, so considering we invest in infrastructure assets that play a critical role in the functioning of that economy, if the economy is growing then that creates positive tailwinds for our assets.
What kind of tailwinds is the asset class currently benefitting from?
Some tailwinds are structural and some cyclical. On the cyclical side, clearly the economic environment today is more supportive than it was in 2020. Governments have indicated fiscal policies supportive of economic growth and identified infrastructure as a means to kickstart the post-covid recovery.
On the structural side, significant tailwinds will be provided by energy transition and digitalisation. We know the impact climate change is having and, regardless of the different paths governments are taking, there’s little doubt we are moving to decarbonise our economies. According to McKinsey, over the next decade $6 trillion is going to be spent on infrastructure to facilitate energy transition across a wide range of sectors.
Communication infrastructure is the infrastructure sector that benefited most from covid as everybody realised the importance of networks being able to handle more data and move it faster. We are all transitioning from 4G to 5G and covid has increased the speed of such transition. The perimeter of communications infrastructure is also getting bigger and bigger, with data centres and fibre deals now regarded as core infrastructure.
How are you and others now integrating ESG into your decision-making processes?
We invest in an asset class where ESG has always been relevant, and we have been at the forefront of this. We invest in long duration assets that need to withstand the impact of climate change, and also very often impact climate. Our assets play a critical role in society, with significant social implications, and they have many stakeholders so corporate governance is important.
Since we started investing in listed infrastructure in 2010, we thought that in order to deliver superior returns we have to account for sustainability drivers, so we embedded ESG in our investment process. Our investment decisions are based on quality and value: value is self-explanatory, but quality is a more subjective assessment that we make based on 10 distinct quality scores. Three of these scores are environmental, social and governance which make up 25 percent of our overall quality score, making ESG is a key feature of our process.
Over the last three years we have partnered with dedicated ESG data providers, because we realise how important data comparability is. We are invested in up to 40 assets at any one time, and we look at an investment universe of over 200 companies, so data comparability across the entire universe is important to everything we do and is key to helping us make better decisions on sustainability drivers.
Another key element of our ESG efforts is engagement with companies in which we invest. We are a minority shareholder, so that interaction is not at the same level as it would be for a private fund owning a majority stake. But given we are specialists in the sector, management of companies in which we invest tends to welcome our engagement on ESG topics. We have increased further that level of engagement as we want to make sure we voice our interest and the interests of the clients on behalf of whom we are investing.
What are your predictions for the asset class in 2022, and what do you see as the big themes going forward?
Looking ahead and leaving aside the structural thematic like energy transition and digitalisation, in 2022 I think the biggest theme will be the recovery of the global economy post-covid, the impact that the recovery has on inflation, and the impact all that has on decision-making in central banks. It will likely be a year where economies show growth, inflationary pressures continue and interest rates start moving upwards.
In that context we believe our portfolio, which is a portfolio geared towards higher levels of economic activity and a rising interest rate environment, should do well on both an absolute and a relative basis. We believe 2022 will be very positive for the asset class.
Finally, active management will, in our view, play a strong role in listed infrastructure going forward. If you look at our investment universe a decade ago, valuations were compressed and so expected returns on assets were pretty much within a narrow band. As we move into 2022, and because of covid and energy transition, the range of valuations on infrastructure assets is much wider so stock picking is going to be a lot more relevant to generate returns. Suddenly active managers like ourselves have an opportunity to exploit.