Opportunities in global infrastructure via ASX
Catch-up after GFC driven by strong demographic trends.
Australian investors are familiar with infrastructure as an asset class. The domestic sector is relatively mature and well understood after many years of government privatisations, yet there are only 15 infrastructure stocks listed on ASX, most of which operate utilities, toll roads or airports.
The global listed infrastructure sector has a much broader scope, with exposure to developed and developing markets, and there are additional subsectors not represented on ASX, such as wireless communication towers and water utilities.
The global universe of listed infrastructure stocks is large and liquid, with nearly 350 infrastructure companies representing more than a dozen subsectors and spanning a multitude of geographies.
The long-term prospects for global listed infrastructure are underpinned by the need for infrastructure development all over the world. There is a continuing need to replace existing ageing infrastructure in developed markets, and increasing requirements for investment to accommodate powerful demographic trends in developing markets, such as population growth and urbanisation.
Many governments have under-invested in infrastructure in the past, but fiscal budget constraints and ongoing stresses in the wake of the global financial crisis are restricting their ability to meet the challenges ahead. Governments are therefore incentivising the private sector to help fund, develop and operate infrastructure.
For investors, the global listed infrastructure sector offers exposure to these potential tailwinds with diversification and the defensive qualities of the asset class.
Figure 1: The global infrastructure universe
A global approach to investing in the asset class is critical, as investors can benefit from the diversification of being exposed to numerous regulatory, political, economic and currency regimes.
Figure 2 below shows the wide disparity of returns between the best and worst performing segments (or subsectors) of global listed infrastructure each year, highlighting the active management opportunities for specialist fund managers.
A significant benefit of investing in listed infrastructure stocks is that allocation changes can be made much more rapidly than with direct investment in infrastructure assets.
Figure 2: Performance dispersion creates opportunities for managers
At September 30, 2016. Source Argo.
Key risks for global listed infrastructure
Although portfolio diversification helps to reduce many of the more specific company or geographic risks, there are two general areas of risk that are relevant to the listed infrastructure sector – regulation and interest rates.
We view regulatory risk as the most significant consideration for the sector, as infrastructure companies are often heavily regulated by governments because of the importance of their operations and assets to the community.
Adverse regulatory change can have a substantial effect on infrastructure companies, although governments must keep in mind that if regulation becomes too restrictive, the private sector will not make sufficient returns to continue its investment.
Since the global financial crisis of 2008-09, the line between regulation and politics has become increasingly blurred. Regulators, who are tasked with maintaining high service quality at a reasonable cost, have remained somewhat predictable regarding outcomes.
However, politicians, with very different agendas and time horizons, have looked more and more to confiscate economic returns from regulated or concession-based infrastructure businesses. Despite this, we believe the period of peak political and regulatory risk, which occurred during several years of “austerity” following the GFC, may be behind us.
As capital-intensive businesses, infrastructure companies tend to be sensitive to changes in global interest rates. That sensitivity, however, varies across the infrastructure universe.
While the asset class has typically reacted negatively to rapid increases in interest rates, performance has historically improved over the long run as the initial shock of higher rates wears off and investors begin to focus on fundamentals.
Figure 3 below shows that after an initial downward reaction to yield spikes, infrastructure stocks subsequently produced strong performance.
Figure 3: Infrastructure has shown resilience after interest rate rises
At December 31, 2016
Impact of the new US political regime
The Republicans now have control of the White House and Congress, which increases the chance of an infrastructure push in the US, together with lower tax rates, tax reform and reduced regulation.
An improved growth outlook associated with President Trump’s potential policies should benefit the more economically sensitive subsectors, such as freight railways. Also, midstream energy companies should benefit from easing restrictions on oil and gas production and reduced environmental empathy.
However, policy uncertainties may result in higher volatility until there is more clarity about what Trump will do.
Globally, the political environment for infrastructure spending is positive. Fiscal stimulus packages specifically targeting infrastructure, combined with deteriorating service quality and stretched budgets, should drive a longer-term focus on more efficient private-sector financing, ownership and operation of infrastructure assets in the US and globally.
Three key offshore themes in global infrastructure
Compelling opportunities exist in the wireless communications tower subsector, particularly in Europe, which revolves around the increasingly data-intensive nature of wireless traffic, as well as expected growth in demand for wireless devices. To accommodate the increasing data intensity of wireless traffic, telecommunications carriers are reportedly investing heavily in their networks, requiring more leased space from cellular tower companies to house equipment.
2. Midstream energy (including pipeline operators)
The outlook is that the global oil market is shifting into undersupply and that North America will gain market share as a global energy supply source. North American producers generally have lower up-front investment costs, which gives them a considerable advantage over most other production alternatives. Over time, midstream energy fundamentals should strengthen as commodity prices rise, volumes grow and the supply/demand balance for pipelines improves.
3. Freight Railways
North American freight rail operators continue to benefit from expectations of strengthening economic conditions. US and Canadian freight rail volumes also appear to be improving, with cost-cutting and efficiency gains a continued benefit for the subsector.
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