The new infrastructure environment

Oksana Patron finds out how the changing macroeconomic environment will affect infrastructure assets and how smaller investors can access the sector.

Despite some red flags on the horizon, the historically low interest rate environment has allowed the strong appetite for infrastructure assets from both institutional and retail investors to continue. 

According to fund managers, this appetite has been further cemented thanks to the asset class’ ability to offer consistent returns over the long-term.

However, some experts have warned that although the fundamentals around the infrastructure sector may still look appealing, investors would need to be more selective when it came to the assets they wished to own in the future. 

At the same time, they would need to remember that not all infrastructure projects are ‘winners’ and should factor in potential hits on their investments.

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Lazard Asset Management’s portfolio manager and analyst, Warryn Robertson, said: “You’ve got to be careful as not every infrastructure project is going to be a winner but generally speaking Australia has been a good destination for infrastructure capital”.

According to Colonial First State Global Asset Management head of infrastructure in Australia, Danny Latham, one of the key questions that needed to be asked in the near future would be what products, in terms of infrastructure assets, would be available for each of the investor groups and how they could be accessed. 

“It has been really all about getting access to the sector. The main thing is really around, particularly from the financial planning side, the self-managed super and mum and dads, is probably a question of liquidity,” he said explaining that many products, and in particular those in unlisted form, tend to have an absolute minimum investment threshold of around $5 million.

“I think the next stage is that we need to divide products to allow smaller investors to get access to the sector,” he said noting that it was still “a work in progress” and that the market was not there yet.

Furthermore, infrastructure company returns had been very strong for an extended cycle, which strengthened the assets’ reputation as a “safe haven in an uncertain world”, according to Robertson.

“It is pretty clear why the relative security of these stable infrastructure revenue streams have been in great demand,” he said.

“In some instances when you think about financial planners when they build portfolios, for the retirees predominantly – they’ve got some other incentives in mind and infrastructure plays a key role in those portfolios in a number of ways.” 

Robertson said investors were moving into the infrastructure space to replace some lower returning assets and deemed them “somewhat safe assets” despite knowing the move was riskier.

“The second area is where investors want to get back into equities but they have been cautious about the volatility the equities market brings. As a consequence they want to look for safe heaven equities and the high dividend yields and stable consistent streams of cashflow that infrastructure stocks can produce,” he said.

“And in some instances people have been using it as a replacement or complement to property investments, given the risk characteristics are quite similar.”

Pricing

According to AMP Capital Core infrastructure fund manager, John Julian, the real challenge for investors targeting the infrastructure sector was to find parts of the market where they could achieve returns and invest at reasonable prices.

“Infrastructure pricing generally is a very topical issue at the moment and that is one of the first questions that I am often asked by advisers, and probably the second hot topic at the moment is around interest rates and what the impact is on infrastructure in a rising interest rate environment,” he said. 

Julian noted that, relative to historical measures, the pricing of some assets such as those leveraged to grow, including airports, ports, and toll roads, remained quite reasonable.

However, in recent years they were not as sought-after as ‘yield-producer’ assets that included regulated utilities.

Julian said that due to the rising interest rate environment, economic conditions would likely improve and subsequently boost assets that were leveraged to grow.

Interest rates

According to Robertson, one of the issues investors faced today was the future of interest rates over the next one to three years.

He stressed that investors in today’s world need to be very careful when it came to picking the right assets. 

“Today you’ve got to be very selective about the infrastructure stocks that you want to own – five, seven years ago (when Lehman Brothers collapsed) it was quite easy to find a number of investment opportunities that would generate very strong returns,” Robertson said.

“That was relatively easy to achieve seven, eight years ago. It’s much more difficult to find stocks that can generate that level of return today given the clouds that we see on the macroeconomic horizon.”

A similar concern was raised by Martin Currie Australia’s portfolio manager, Ashton Reid, who said that the number one question was what would happen to real assets when faced with higher interest rates.

“We as an investment house think that interest rates do need to go up – so our answer to the investors on that scenario is that we have seen some volatility in the pricing of the real assets on the stock market and that’s created volatility in the yields,” Reid said.

“That raised some concerns with investors but we haven’t seen any issues in cash flows or dividends of the investments that we buy so it’s really purely about what price the market is prepared to pay for that income stream.

“And I would be much more concerned if I had seen the dividend being cut,” he said.

“Interest rates do need to go up because they should be approximating our nominal growth in GDP [gross domestic product] – so that’s running at around three per cent.”

Julian noted that he expected the economic environment around the world to improve.

“We are seeing some countries, most notably the US, talking about raising interest rates. I think that it’s important in relation to each of those points to note that even though we are seeing the improving economic environment and the US is talking about raising rates both of those things are going to be quite fragile,” he said.

“I don’t think [for example] that we are going to return to strong global growth in the near term but it’s improving compared where we were a year or two ago – what that means in terms of infrastructure is that different types of infrastructure will be impacted in different ways.” 

Stock picking

Fund managers further expected a good supply of opportunities for infrastructure investments both globally and within Australia.

Additionally, the differences in the advancement of the infrastructure sector between the developing and developed markets would also enhance the selection of options for investors.

Latham said: “I think as with the growth and the development of the sector and the greater segmentation, there’s an increasing opportunity for investors to access products that meet their own risk return and liquidity objectives”.

On the other hand, Robertson warned that there was a number of mispriced assets in the market and that both ‘mum and dad’ investors and institutional investors would face the same problem if they chose to chase low-cost passive index alternatives.

“The infrastructure indices, the passive investment in the infrastructure, yes they are cheap in terms of costs but we think they are looking expensive. And that’s what the potential problem is for investors who track those indices or who buy those index products,” he said.

“They’ve gained popularity because they are in a low return environment and they offer low fees.”

Robertson also said that quantitative easing over the past five years had provided a good investment environment for those choosing passive investments but “this is coming to an end”.

“Stock selection is going to be far more important over the next five years. While just being in the market was enough five years ago, now it’s about picking the stocks you want to own,” Robertson said.

“You have to be concentrated and avoid those expensive parts of the market.

“We still believe in what we call a ‘preferred infrastructure’ which is the assets we’re investing over the long run. It would be a really good place for investors because they provide low-volatile equity-like returns but with inflation protection and consistent income generation.”