Going global with your infrastructure investments can yield a more defensive portfolio, with more stable returns and lower volatility, writes Perry Lucas.
Australian fund managers have been pioneers in the development of infrastructure as an asset class. As a result, there is a bias among Australian investors investing in Australian infrastructure assets.
Unfortunately, this means missing out on some 98 per cent of the opportunities that world infrastructure markets have to offer. Moreover, sticking to Australia may be a riskier strategy than going global.
The lucky country?
As with most markets – and share markets in general – Australia accounts for a small percentage of the world opportunity set.
Based on listed market estimates, investors who stick to investing in Australia alone are potentially missing 98 per cent of global opportunities.
In fact, based on a broad market portfolio of 133 global infrastructure securities held in the AMP Capital Global Infrastructure and Utilities Index (a proxy for the global infrastructure market), in the five years to February 2011, Australia demonstrated the highest annualised volatility in returns across the countries and regions in which AMP invests.
There was a significantly lower level of volatility in the United Kingdom, Japan, the United States and Canada.
These countries all have fairly developed infrastructure markets – some of which are larger than Australia’s. This is in part due to the relatively small size of Australian markets.
Though we have been investing in infrastructure longer than most other nations, we are still a small and constrained market when compared with the developed markets of the UK, Europe and North America.
When comparing volatility across countries, the listed airport sector provides an interesting example. Table 2 summarises the annualised volatility of eight listed airport investments in the AMP Capital Global Infrastructure and Utilities Index over five years.
Holding only Australian airport securities would have exposed investors to a volatility of 33.87 per cent over the five-year period, while adding European and New Zealand airport exposures could have helped reduce overall volatility for an allocation to listed airport securities.
Investing solely in Australia exposes investors to more volatility based on the relative concentration in the Australian infrastructure market. Global diversification by adding global sectors and geographies with lower volatility potentially will lower an investor’s overall portfolio volatility.
Diversification benefits
To achieve portfolio diversification, gaining exposure to a mix of sectors of geographies with low correlations among them generally means that returns do not move all at once, which moderates the highs and lows in a portfolio.
By sticking to an Australian-only infrastructure investment strategy, investors will miss out on the diversification benefits a global infrastructure portfolio can provide.
For example, figure 1 demonstrates the correlations between Australian infrastructure returns and those across other countries and regions in the AMP Capital Global Infrastructure and Utilities Index.
The data shows that for the last 10 years, Australia was correlated to the Index portfolio to a factor of 0.62, and similarly 0.60 for the MSCI World index.
However, lower correlations to the UK (0.36), New Zealand (0.35), Canada (0.18), and Japan (0.11) highlight relatively low correlations available to investors whose strategy encompasses a global portfolio of infrastructure securities.
Adding infrastructure to a portfolio
In addition to the overall benefits of diversifying infrastructure investments globally, at a higher level, adding infrastructure to a portfolio adds overall diversification benefits relative to other asset classes.
Figure 2 shows the correlations between listed infrastructure and utilities against other key sectors. For example, there is a strong correlation with global listed infrastructure securities at 0.64, as would be expected.
However, at the other end of the scale, correlation with unlisted infrastructure investment is low at 0.31. It is also low against international bonds (0.19), Australian bonds (0.03) and Australian direct property (0.01).
The diversification benefits are even more pronounced with the addition of global unlisted infrastructure to a portfolio. Figure 3 illustrates that correlation between unlisted infrastructure and other asset classes range from a low of 0.1 to a high of just 0.36.
On a total exposure basis, adding either listed or unlisted infrastructure offers diversification benefits to a total portfolio, while adding global geographic diversification can further enhance the overall diversification benefits within an infrastructure allocation.
Getting the right mix
Blending the diversification benefits globally, by adding international listed to an unlisted portfolio yields a significant reduction in volatility.
In this case we have used an Australian unlisted portfolio because of the limitations in obtaining long-term return data on a global unlisted portfolio.
Figure 4 shows asset class returns adjusted for risk for the 10 years to December 2010. On a volatility adjusted basis, the steady returns for infrastructure assets, both listed and unlisted, stack up well compared to other asset classes over the long term.
Over the last 10 years, listed global infrastructure as measured by the AMP Index returned an average of 9.7 per cent per annum, with volatility of around 11 per cent, while unlisted infrastructure portfolios delivered an average of 9.3 per cent per annum, with volatility of around 8.7 per cent.
However, blending both listed and unlisted infrastructure exposures produced a return of 9.7 per cent per annum, but with an even lower volatility than both listed and unlisted of around 8 per cent, based on a 50/50 investment mix.
Clearly, investors who stick to an Australian only investment allocation are missing out on significant diversification benefits available in the global infrastructure market. Moreover, they will likely experience higher volatility than some of the other international markets. Blending both listed and unlisted infrastructure investments together in a global portfolio can significantly reduce overall volatility without forgoing returns.
Perry Lucas is portfolio manager of AMP Capital’s Core Infrastructure Fund.
