Portfolio Manager – Core Infrastructure Fund, AMP Capital
Head of Global Listed Infrastructure
Listed and direct infrastructure equities can exhibit differing returns, volatilities and correlations. This article discusses how these asset classes perform relative to each other in an investor’s portfolio, focusing on the investment opportunities within each.
Listed and direct infrastructure with the same economic exposures will behave similarly to changes in the economic environment. However, valuations and returns between the listed and direct assets may not always move in sync.
Listed valuations tend to respond more rapidly and are influenced by general market sentiment, which results in higher relative volatility, whereas direct asset valuation cycles are typically bi-annual with fewer unlisted comparative transactions. Transaction prices are based on the business fundamentals and are not influenced directly by listed market sentiment. Consequently, volatility is lower. For instance, as the economic cycle turns down, the decline in listed valuations tends to be faster and more pronounced than direct, providing arbitrage opportunities. On the other hand, the listed market can provide access to many infrastructure assets that are underrepresented in unlisted infrastructure and can assist in improving diversification.
Correlation analysis may also indicate low – even negative – correlations between unlisted and listed infrastructure growth rates in different asset sectors. This can create significant diversification benefits for a portfolio that combines both listed and direct assets.
As the listed infrastructure market cap is US$2.6 trillion – approximately three to four times larger than direct, the opportunities are immense.
Investment opportunities – direct infrastructure
We expect there will be some improvement in unlisted asset availability in the coming years, with the supply of new infrastructure assets expected to increase by approximately US$100 billion in the four years to 2020. This is a significant increase compared to previous years and is primarily being driven by the recycling of assets from the infrastructure funds, largely in Europe, which will mature during this period. Another important source of new supply will come from privatisations, particularly in Australia (electricity and ports) and possibly in Japan (airports).
Investors in large direct infrastructure assets often tend to be long-term institutional holders focused on a smaller number of larger investments. Overall, we anticipate that demand from institutions and pension funds for these assets will continue to exceed supply for the foreseeable future, creating persistent upward pressure on prices in this segment of the market. In this environment, mid-sized infrastructure assets can provide the best opportunities for value investors. There is also a potential early mover advantage for relatively new investors in adopting a strategy for investing in mid-sized assets, as there is a possibility of multiples from larger assets filtering down to smaller transactions.
Investment opportunities – listed infrastructure
Our view is that we are in a ‘lower for longer’ yield environment globally and we think the Fed will be cautious given generally weak global growth. In this weaker return environment, we expect continued strong demand for real assets that offer high and sustainable yields.
While market volatility has characterised the start of 2016, this has created interesting opportunities for dedicated infrastructure equity managers. We are focused on identifying companies that have been unfairly impacted by general market sentiment and whose fundamentals haven’t changed. Of particular note, we believe there are standout investment opportunities emerging in North American infrastructure energy pipelines. Share prices for energy pipeline companies have fallen significantly, in some cases by 60 to 70%, but the underlying fundamentals of many of these assets have remained intact. We are attracted to companies in this sector that don’t need to access capital markets, have limited counterparty risk and secure contracts in place.
Looking further ahead, security issuance is expected to continue as governments sell publicly-owned infrastructure assets into the listed market. In addition, companies that own infrastructure assets that are not valued by the market will seek to realise these assets by listing them (for instance, oil and gas exploration companies listing their pipelines and gas processing plants) and using these proceeds to reinvest back into exploration. These two trends have contributed to the number of stocks in our listed infrastructure investable universe rising by almost 50% during the past 12 years.
Demand for direct infrastructure assets has been robust, driven by the ongoing search for yield combined with lower fixed income yields, increased supply and strategic investment drivers. In the current low interest rate environment, independent valuers of direct infrastructure assets may incorporate additional risk factors (alpha factors) in the discount rate used in their valuations that address the risk of future interest rate rises.
The existing low interest rate environment is characteristic of a low growth environment, and interest rates are unlikely to increase unless there is a significant uplift in economic activity. In these circumstances those direct infrastructure assets that are leveraged to economic growth, for example those that benefit from increased demand or patronage, may benefit from this growth such that the positive impact of this growth on valuations may exceed the negative impact of interest rate increases.
Listed infrastructure is a relatively young asset class, subject to a variety of valuation approaches from the investment community. This creates pricing anomalies and market inefficiencies, which are managed by investors and investment managers by applying a long-term valuation approach.
Historical analysis of capital growth rates in listed and direct infrastructure confirms that unlisted capital growth has exceeded listed capital growth during recent years. However, the recent declines in listed markets suggest that the listed sector can potentially deliver higher returns than the unlisted market – however, relatively higher listed market volatility might be a concern for some investors.
Investors seeking to compare valuations across varying investment managers and market segments should be mindful that differing approaches can make comparability a challenge. The general characteristics of infrastructure equity – both listed and direct – serve to diversify portfolio risk and they both can be highly complementary so a holistic approach may help meet investor needs.
Find out how to invest with the AMP Capital Core Infrastructure Fund and
AMP Capital Global Infrastructure Securities Fund.
Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.