Will high inflation be a ‘defining moment’ for infra?

Credit where it’s due: in late 2017, when inflation wasn’t exactly a fashionable topic at dinner parties, Anton Pil, JPMorgan’s global head of alternatives, spent a considerable part of the keynote interview he did with us worrying about it.

“There’s generations of investors now that have never experienced inflation in the marketplace,” Pil told us, adding that the asset class hadn’t really been tested by a period of high inflation. “If we do see inflationary pressure pick up in the US, especially if it’s above expected, that could be a defining moment for infrastructure. Infrastructure is absolutely critical for the part of the cycle where you see inflationary pressures pick up.”

Pil used JPMorgan’s infrastructure portfolio, heavy on contracted and regulated cashflows, as an example of what investors could expect: “We believe that our cashflows will increase about 80 percent of what inflation goes up.”

Five years later, we are all living in Pil’s world, with inflation at record highs across the globe. And while the jury is still out on how long this period of high inflation will last, it is likely to stick around long enough to test the asset class.

So, how is infrastructure doing?

Early signs are encouraging, with Fitch Ratings finding the asset class is weathering the inflation storm well. “It speaks to the resiliency of infrastructure. It performs well and stays stable, even in volatile markets,” Gregory Remec, Fitch senior director of global infrastructure and project finance, told us.

That is good news for infrastructure. Combined with the essentiality it has already demonstrated during the covid pandemic, inflation should paint a target on the asset class’s back for those investors that are still underweight on it.

Like Pil, Remec described the “ideal [infrastructure] asset [as] one that has its revenues adjusted at the exact same level that the expenses are adjusted, so both go up in lockstep”.

But while the mechanics of how some infrastructure assets can withstand inflation are easy to understand, they are about to be tested at a time that is significantly different from the 1970s and 1980s, when the last high inflationary period occurred.

One important difference is the tension between the private sector’s traditional goal of generating profits for its shareholders and its more recent pledges to invest responsibly/sustainably, taking all stakeholders into account and ‘doing no harm’ to the communities it operates in.

Needless to say, the latter will be difficult to achieve when the practical effects of revenues rising in lockstep with expenses – in the middle of a full-blown cost of living crisis – will in many cases translate into ballooning consumer bills and potentially hard choices between eating or keeping the lights on.

In what could turn out to be a revealing moment, this is all coming to a head as ESG, the bedrock of responsible/sustainable investing, is besieged by greenwashing scandals, widespread scepticism and high-profile attacks by the likes of Tesla chief executive Elon Musk.

Tesla, recently dropped from S&P 500’s ESG index, is actually a good example of how demanding responsible investing is turning out to be. “How can a company whose self-declared mission is to ‘accelerate the world’s transition to sustainable energy’ not make the cut in an ESG index?” Margaret Dorn, S&P senior director and head of ESG Indices, North America, wrote, posing the question on everyone’s minds. You can read the full explanation on Dorn’s blog but suffice to say Tesla’s commitment to the ‘E’ was not enough to counterbalance issues with the ‘S’ and the ‘G’. 

When it comes to infrastructure, it is the fragile balance between its inflation-proofing characteristics and the social and political costs they carry that is worth watching in this high inflationary period – especially if it becomes a prolonged one.

How investors manage this and reconcile it with their own pledges might turn out to be the asset class’s real “defining moment”.