Nominal interest rate increases will not have a detrimental effect on valuations of infrastructure securities, according to Geoff Frankish, head of infrastructure at Goldman Sachs JBWere Asset Management.
“Generally speaking, the view is that increases in interest rates, accompanied by inflation, are going to be detrimental to the valuation of infrastructure stocks, but if you look at it analytically, this is not the case,” he said.
“That is because the revenue benefits flowing from higher inflation broadly offset the adverse impact of higher interest rates on financing costs and the discount rate.”
However, if there were real increases in interest rates, where for some reason interest rates increased faster than inflation, these would be negative for valuations.
“This is because the second and third effects (of real interest rates rises) are going to be bigger than the offsetting revenue effects (from inflation).”
Speaking at a media briefing in Sydney yesterday, Frankish said real interest rates have been trending downwards over the past four or five years, which has contributed to strong increases in valuations in infrastructure securities.
By contrast, he said if there is a “reversal of that trend, then you would get a negative impact on valuations”.
The Australian market cap for infrastructure securities has grown from about $10 billion in mid-2000 to about $70 billion currently, and, according to Frankish, is set for further growth over the next few years.
“It is going to continue to grow — not at the same pace as it has been, but certainly at a pretty rapid pace.”
He said financial markets have been an “important factor in the underperformance of the infrastructure market in the past three or four months, particularly concerns over the availability of credit”.
However, he said “evidence is emerging that this is a concern that is probably a bit misplaced”.
“There are a number of examples of refinancing of good assets that has occurred without undue stress, admittedly with some higher margins, but those margins had become pretty skinny in the first place.”
