Infrastructure and growth: the never-ending cycle
Global listed infrastructure may be one of the least known asset classes with some of the most impressive dynamics driving its growth.
Among these dynamics are the massive investment requirements for infrastructure globally, a determination by governments to encourage greater investment in infrastructure by the private sector, unique cash-flow characteristics, and manageable risks.
The need for infrastructure investment is a never-ending cycle as it helps stimulate sustainable long-term economic growth, which then creates further need for infrastructure.
Ultimately, infrastructure promotes higher living standards as it fosters growth in economies. The World Economic Forum estimates that every dollar spent on infrastructure generates an economic return of between five per cent and 25 per cent. Infrastructure is the backbone for economies to develop and remain competitive.
The future growth in infrastructure is not only driven by the need for new infrastructure but also to replace existing ageing infrastructure.
Since the 1970s, real public infrastructure investment in advanced economies has been falling as a percentage of gross domestic product (GDP).
This has left many infrastructure projects deferred and even abandoned, ultimately magnifying the infrastructure gap. Consulting firm McKinsey has forecast that a US$57 trillion investment is required on core infrastructure alone between 2013 and 2030 just to keep up with GDP growth.
The huge investment requirement is across all geographies, developed and developing worlds, and transcends all sectors, but we think it will be dominated by transport, energy, water and communication.
Water
An expanding human population, coupled with unpredictable global water distribution, makes the ability to store and efficiently deliver a reliable water supply imperative. The majority of demand is driven by Asia Pacific.
Energy
The production and supply of energy will become increasingly important in enabling and maintaining global economic growth. The sources of energy continue to evolve, and not just from fossil fuel to renewables.
Transport
The Organisation for Economic Co-operation and Development believes GDP could double by 2030, which could result in airline traffic growing by 4.7 per cent per annum and rail and freight traffic by two to three per cent per annum between now and 2030.
Communications
Communication infrastructure, such as mobile phone towers, has rapidly advanced during the past decades. While many countries have upgraded their infrastructure, the rapid pace in which technology is advancing means countries will continually need to invest to stay globally competitive.
A shift in roles
Governments have traditionally been the providers of a nation's infrastructure and have undertaken most of the investment financed by a combination of tax revenues and tax revenue-backed debt.
Since the global financial crisis (GFC), however, government finances have come under considerable stress due to lower tax revenues and increasing expenditures, resulting in many embarking on austerity measures aimed at reducing spending.
With only minimal success to date, and further structural pressures on government finances in the developed world, the ability of governments to maintain their role as the primary provider of infrastructure will weaken. Further involvement of the private sector in the provision of infrastructure is therefore inevitable.
"The need for infrastructure investment is a never-ending cycle as it helps stimulate sustainable long-term economic growth, which then creates further need for infrastructure."
Different governments are at various stages of the continuum of involving the private sector in providing their infrastructure, and the model varies greatly from country to country.
Those who are most advanced, like the UK and Australia, recognise that private sector infrastructure companies value transparency, certainty and the ability to manage risks in the regulatory frameworks or contracts.
The financial models have been developed in these countries to best share risk between the public and private sectors, evident in structures like Public Private Partnerships and frameworks for privatisations.
Governments are aware that maintaining regulatory and contract frameworks that provide stable, reliable cash flows that grow, over the long-term, contribute to lowering the risk premium for a nation and their investments.
These conditions are the basis for a structural growth story for both direct and listed infrastructure investment.
Growth opportunity
Looking specifically at global listed infrastructure, we expect continued stable, reliable, cash-flow growth from our companies of seven per cent to nine per cent during the medium to long-term.
The cash-flow generation from undertaking further investments sees global listed infrastructure companies trading on attractive cash-flow yields, well above their dividend yields, providing scope for ongoing investments, at attractive returns, of increasing dividends.
Despite the growth seen in recent years, global listed infrastructure does not have a widespread definition as an asset class.
The broadest definitions include companies that own a diverse range of assets and have cash flows that are exposed to varying risks, many of which would not normally be associated with an infrastructure investment.
Therefore it is imperative investors understand the underlying exposures of an infrastructure investment, and the risks the cash flows generated by the companies' assets might be exposed to.
At AMP Capital, we only focus on ‘Core and Pure' global listed infrastructure companies such as oil and gas storage, transmission and distribution, toll roads, airports, ports and communications as their cash flows are exposed to fewer risks, and we have found they produce greater risk-adjusted returns than companies that exhibit fewer ‘infrastructure' characteristics such as railways, shipping logistics and construction companies.
In terms of where global listed infrastructure sits in a portfolio, many investors allocate to it from their equities holdings and view it as a way of accessing sustainable income with long-term capital growth, less volatility than global equities and immediate exposure to the infrastructure thematic.
Within a balanced portfolio, it displays complementary attributes to other asset classes and has useful diversification benefits due to its low correlation to global equities and other asset classes.
For example, it can play the role of a low-risk bedrock within a global equities allocation, quickly increase a real asset exposure due to its high liquidity, and is an attractive low-risk alternative for fixed income investments.
Government's role
No investment is without its risk and some of the risks facing global listed infrastructure companies are cash-flow exposure to a regulatory framework or contract, inflation, interest rates, economic growth, and subsequently, volume, commodity prices such as oil, and industry dynamics such as competition.
However, governments and regulators are complicit in reducing these risks with the expectation that lower risks result in investments being undertaken at a lower rate of return, meaning a lower final tariff for the consumer or a higher selling price if the asset is being sold (or leased).
Global listed infrastructure is currently where the global real estate investment trusts sector was around 20 years ago, with considerable potential as the asset class continues to evolve.
As a result of the global demand for infrastructure and a positive environment for investment, global listed infrastructure is likely to experience strong growth for decades to come.
Tim Humphreys is the head of global listed infrastructure at AMP Capital.
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