Signs seem to be pointing to a new era for global markets, according to Jeremy Anagnos, CBRE Clarion Securities’ chief investment officer for global infrastructure. For the first time in decades, inflation is on the rise and many investors are unfamiliar with how these headwinds could affect their portfolios.
Not only is infrastructure an asset class well positioned to weather these changes, but Anagnos believes listed investments have unique benefits that can provide insulation from these changes, and even growth. Below, Anagnos explains how investments in public infrastructure companies can provide a hedge against global financial trends not seen since the 1970s.
Q: How is infrastructure poised to weather rising inflation?
JA: This year, the threat of inflation is becoming real. We’re beginning to see data that points to higher inflation in developed markets. Immediately, what people are seeing first is higher bond yields, and that’s been viewed as a negative for income assets, which includes infrastructure. However, what people are forgetting are the benefits the asset class has to withstand inflation.
One benefit is that owning assets allows companies to pass inflation through via higher prices. Think about it as pricing power: toll roads, airport concessions or power owners who have contractual increases built into their contracts for the underlying asset. In jurisdictions such as the UK and Italy, for example, regulated returns are based on real returns, which takes into account inflation, allowing a direct link to pass on those increases in inflation.
The other way to think about it is on the investment side. Companies are continuing to invest capital. Generally, if you have rising bond yields, you have rising cost of capital. Debt costs go up. But infrastructure with regulated returns, even if it’s not set to a real return, a regulator is using the notion of a spread to cost of capital to determine what the company should be earning on an investment. So, as we see investment growth, companies putting capital to work, they will be earning a spread over their cost of capital. As cost of capital moves up with higher bond yields, they will earn higher returns and hedge the inflation.
Q: How much of a disruptor can inflation be to investors?
JA: Most investors, unless they have experience from the 1970s, have been around in a period of low and declining inflation. If you look at investment cycles over the long term, I don’t think it’s likely we repeat that period. I’m not saying we’re heading toward hyperinflation, but I do think investors should begin to understand what implications rising inflation over long periods of time could mean for their portfolios. Preservation of capital through rising revenues alongside inflation is one way to protect your returns in inflationary periods.
Q: Do you think infrastructure companies can generate attractive returns in periods of rising inflation?
JA: Listed infrastructure securities offer dividend income which reflects a 60 percent payout of earnings. The 40 percent of retained earnings is being reinvested. The reinvestment of earnings, and expected higher returns as inflation rises, is what’s driving the higher-than-inflationary growth that’s expected from the market and what they’ve historically been able to deliver.
Q: Is listed infrastructure better insulated from inflation than unlisted?
JA: The underlying assets are similarly positioned, but one benefit of listed infrastructure is that companies are not typically paying out all their distributions. They typically have a lower ongoing yield that’s close to 4 percent, reflecting the 60 percent payout ratio, rather than 6 percent-plus for a fund distribution yield, which reflects a near-100 percent payout of cashflows. But the listed companies are reinvesting those cashflows to drive future growth and dividends.
Over the past 20 years, the listed infrastructure market has generated 6 percent compounded annual growth in dividends, when inflation, using US CPI, was 2.1 percent over a 20-year period. So, they’re generating inflation-plus – and the plus part comes from that reinvestment.
Q: Can’t private infrastructure investors achieve the same growth?
JA: Investors in private funds can achieve the same growth, theoretically, by taking money they receive as distributions and reinvesting that in new funds. But then you’re subject to transaction costs, reinvestment risk, competitive pricing and other things as you try to acquire assets at market prices. What listed companies are doing is primarily reinvesting into their existing assets, which offers a more attractive return profile than competitively acquiring new assets.
Q: What kind of institutional investor is attracted to listed infrastructure?
JA: Institutional investors come to the infrastructure asset class for a stable return profile. They are looking for those same characteristics in the listed asset class. They recognise they are subject to daily pricing in listed markets, which allows us to offer immediate availability of assets. However, if you’re priced every day, that also means you’re going to see more volatility than if you’re priced every year.
Those investors are making a long-term decision. If you hold it for a long period, you will see the same benefits. We’ve seen a number of institutions make simultaneous allocations into listed infrastructure as a core, and then layering with closed-end private funds that enhance their exposure to a particular sector they feel is more attractive at that time. It gives them more of a J-curve return opportunity – higher returns balanced with a more core exposure on the listed market.
However, those investors I just mentioned are still the minority, but we are seeing it happen among local pension funds and larger institutions.
Q: Should investors invest in either listed or unlisted infrastructure?
JA: I don’t think it’s an either/or. I think it’s an ‘and’. Listed infrastructure offers immediate investment into the asset class in a very diversified way across sectors and geographies. That also means across regulatory and political risk profiles. There’s also a liquidity angle that allows investors to change allocations to the asset class over time. So, if you want more or less exposure, you can use the listed side to increase or reduce that exposure. That’s much more difficult with investments in private funds or directly in assets.
You are also seeing a significant discount when these assets are being valued in a listed wrapper than the same assets being traded in the private market, somewhere between a 20 percent and 30 percent discount of the listed market valuation of the same assets held or transacted on the private side.
Finally, investors will find a lower fee structure associated with the listed market than you would see on the private side.
Q: What do you think when you hear someone say listed infrastructure isn’t as competitive as a private investment?
JA: I understand where the investors are coming from. They’re judged on a certain metric, and that’s solely standard deviation. I’ve spoken to a number of large institutional investors who are more long-term and sophisticated in their understanding of what defines ‘volatile’. Lack of a valuation point doesn’t necessarily mean lack of volatility.
With listed infrastructure, if you hold it for one year and the volatility really matters to you, then I would say it’s not the appropriate approach. But if you have a longer time horizon and want exposure to a diversified, core infrastructure portfolio at a reasonable valuation, recognising the day-to-day volatility, then it could be the right way to go. n