Infrastructure is back in the news. Sydney Airport and electricity distribution utility Spark Infrastructure beat back takeover bids from yield hungry super funds and private equity groups last week. AustralianSuper is looking at a $3.7 billion infrastructure asset spending spree, according to the FT, and a top Canadian pension fund is set to splash C$70 billion for private assets including infrastructure and real estate.
But infrastructure assets are not just for pension and super funds. Utility AGL (ASX: AGL) is an equity best idea, and Morningstar’s model ETF portfolios recommend an allocation of 5 per cent to global infrastructure for growth and 3 per cent for balanced or cautious portfolios.
The sector spans many types of assets and can be hard to pin down. In this article, we speak with equity analysts and fund managers to shed light on this booming asset class.
What is infrastructure?
Infrastructure is a broad category and could equally apply to a private prison in the US Midwest, a toll road in Melbourne, or a solar farm in Spain.
But the ideal infrastructure asset does have several characteristics, according to manager research analyst Edward Huynh: predictable and stable demand, reliable inflation linked cash flows and a natural monopoly.
Sarah Shaw, the chief investment officer at 4D Infrastructure, a boutique listed infrastructure asset manager, divides infrastructure into essential services, such as gas or water utilities, and those customers pay to use, including ports, roads, airports, and communication infrastructure.
Each infrastructure subtype has a different economic profile, says Shaw. Essential infrastructure is often priced by regulated contracts and is “largely immune” to economic cycles, while assets such as ports are correlated to the economic activity that moves through them.
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More than 90 per cent of infrastructure is unlisted, says Huynh, and out of reach except for investors with hundreds of millions available, such as pension funds or large private equity groups.
Morningstar manager research analysts say about 150 to 200 stocks globally would capture most of the public investable universe, with local names including Transurban (ASX: TCL), Spark Infrastructure (ASX: SKI) and Sydney Airport (ASX: SYD).
Why include infrastructure in a portfolio?
Multi-decade assets and reliable payment streams makes infrastructure attractive for income investors, says Huynh.
“People like REITs for income but infrastructure assets, especially utilities, are more reliable and less cyclical,” he says.
These income streams are often more defensive, with public listed infrastructure only partially correlated with the broader equity market in the long term.
For Shaw these defensive earnings also have growth potential as governments replace aging bridges and rail and build out new infrastructure for the energy transition and the emerging global middle class.
An asset class ranging from wind farms to mobile towers may make classification difficult, but that same variety means portfolios can provide returns for all points of the economic cycle, says Shaw.
Decades long earning streams come with risks and political or social changes can threaten long-dated infrastructure assets. Governments can change pricing contracts and new technologies can threaten older assets, as renewables have done for coal-fired plants.
“If you’re buying a 20-year asset you need to think how the world will look then,” says Huynh.
A tumultuous year for infrastructure
“We weren’t sexy enough” says Shaw, reflecting on a difficult twelve months for the sector.
Infrastructure funds made up six of the top ten worst-performing open-ended equity funds covered by Morningstar, although performance generally improved in the second half of the financial year.
4D’s Global Infrastructure fund returned 11.74 per cent in FY 2021 and has a 5-year return of 9.09 per cent. The fund is not under Morningstar coverage.
“We were punished in the downturn but didn’t participate in the rebound,” says Shaw. While valuations for unlisted airports fell around 5-6 per cent, listed names saw drops of 30 to 40 per cent.
Depressed valuations have spurred a surge of takeover interest from private equity groups and pension funds looking to take these assets private.
“In this case the unlisted valuation has got it right. When you’re talking about a 75-year asset, the drop in value isn’t justified,” says Shaw.
Last week, Sydney Airport rejected a $22 billion bid from private equity group KRR and a Canadian pension fund while it took $34 billion to finally end a month’s long bidding war for US railway Kansas City Southern (KSU) in May. Morningstar’s head of equities Peter Warnes puts the buying frenzy down to an “environment awash with liquidity” looking for a “safe and secure long-term home”.
“Other infrastructure assets, though perhaps not quite in the same class as Sydney Airport, could also be on the radar screens of super funds and private equity,” Warnes says.
He added that “all are tarred with the current obsession over Environmental, Social and Governance (ESG) issues, which I believe are somewhat overdone. This could provide an opportunity.”
Even with private groups snapping up infrastructure assets, the size of the infrastructure deficit means there should be plenty for public markets, says Shaw.
“Somewhere between 60 to 90 trillion in new infrastructure will be needed globally over the next decades, even if only 10 per cent comes into the listed space, that’s plenty.”