Listed or unlisted infrastructure – why not both?
John Julian and Tim Humphreys look at how volatility has created opportunities for dedicated infrastructure equity managers.
Listed infrastructure securities and unlisted infrastructure assets can exhibit differing returns, volatilities and correlations.
It is important for retail investors to understand how these asset classes perform relative to each other in a portfolio when focusing on the investment opportunities within each.
Listed and unlisted infrastructure assets that are located in the same economy will behave similarly to changes in the commercial environment.
However, valuations and returns between listed and unlisted assets may not always move in sync.
Listed valuations tend to respond more rapidly to, and are influenced by, general market sentiment, which results in higher relative volatility.
In contrast, unlisted asset valuation cycles are typically bi-annual, and are based on the business fundamentals and are not influenced directly by listed market sentiment. Consequently, volatility is lower.
For instance, as the economic cycle decays, the decline in the value of listed infrastructure assets tends to be faster and more pronounced than for unlisted infrastructure assets, providing arbitrage opportunities.
On the other hand, the listed market can provide access to many infrastructure assets that are underrepresented in the unlisted infrastructure universe, and can assist in improving diversification in investment portfolios.
Analysis may also indicate low — even negative — correlations between unlisted and listed infrastructure growth rates in different asset sectors. This can create significant diversification benefits for a portfolio that combines both listed and unlisted assets.
Unlisted infrastructure
In a low-return environment, high-performing and relatively low-risk investments are likely to attract a lot of interest.
We have witnessed solid demand for large unlisted infrastructure "trophy" assets from sizeable local and international institutional investors.
This demand has driven prices higher for large assets. High-yielding assets have also been in demand. On the other hand, mid-cap and growth assets have not experienced the same intensity of demand and, as a result, offer better relative value.
Overall, we anticipate demand from institutions and pension funds for these types of assets will remain strong for the foreseeable future, creating persistent upward pressure on asset prices.
AMP Capital expects there will be an increase in unlisted infrastructure asset availability in the coming years.
This will be driven by asset recycling from closed-end infrastructure funds, largely in Europe, which are approaching the end of their life.
Another important source of new supply will come from privatisations, particularly in Australia, for instance electricity and port assets, and possibly in other countries such as Japan where, for example, the government is looking to privatise a number of airport assets.
Listed infrastructure
AMP Capital's view is that a "lower for longer" yield environment will persist globally, and the US Federal Reserve will be cautious in lifting interest rates given generally weak global growth.
In this environment, continued strong demand is expected for real assets that offer high and sustainable yields.
While market volatility characterised the start of 2016, this has created interesting opportunities for dedicated infrastructure equity managers.
AMP Capital is focused on identifying companies that have been unfairly impacted by general market sentiment and whose fundamentals haven't changed.
For instance, there are standout investment opportunities emerging in North American infrastructure energy pipelines.
Share prices for energy pipeline companies have fallen significantly but the underlying fundamentals of many of these assets remain intact.
Companies in this sector that do not need to access capital markets, have limited counterparty risk and secure contracts in place are attractive investments.
Looking further ahead, security issuance is expected to continue as governments sell publicly-owned infrastructure assets into the listed market.
There have been a number of initial public offerings (IPOs) by governments recently, particularly in Europe. Examples include the Spanish airport company AENA and the Italian air traffic control company ENAV.
In addition, companies that own infrastructure assets that are not valued by the market will seek to realise these assets by listing them and using the proceeds to reinvest back into their core business.
An example of this would be oil and gas exploration companies listing their pipelines and gas processing plants.
Future outlook
Demand for unlisted infrastructure assets has been robust, driven by the ongoing search for yield combined with lower fixed income yields, increased supply and strategic investment drivers.
In the current low interest rate environment, independent valuers of unlisted infrastructure assets may incorporate additional risk factors in the discount rate used in their valuations that address the risk of future interest rate rises.
The existing low interest rate environment is characteristic of a low-growth environment, and interest rates are unlikely to increase unless there is a significant uplift in economic activity.
In these circumstances, those unlisted infrastructure assets that are leveraged to economic growth, (for example, those that benefit from increased demand or patronage), may benefit from this growth such that the positive impact on valuations may offset or even exceed the negative impact of interest rate increases.
Listed infrastructure is a relatively young asset class, subject to a variety of valuation approaches from the investment community.
This creates pricing anomalies and market inefficiencies, which are managed by applying a long-term valuation approach.
Historical analysis of capital growth rates in listed and unlisted infrastructure confirms that unlisted capital growth has exceeded listed capital growth during recent years.
Despite the recent rally we have seen in listed infrastructure, the decline in listed markets during the past 12 months suggest the listed sector can potentially deliver higher returns than the unlisted market.
However, relatively higher listed market volatility might be a concern for some investors.
Investors seeking to compare valuations across varying investment managers and market segments should be mindful that differing approaches can make comparability a challenge.
The general characteristics of infrastructure — both listed and unlisted — serve to diversify portfolio risk and can be complementary. So a holistic approach may help meet investor needs.
John Julian is the core infrastructure fund portfolio manager, and Tim Humphreys is the head of global listed infrastructure at AMP Capital.
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