Greg Maclean, Head of Research, Infrastructure
John Julian, Investment Director
The low-return environment has made it tough to find investments that satisfy investors’ objectives.
Advisers have, correctly, encouraged clients to venture outside the usual menu of assets, such as listed stocks and bonds.
Many, for example, have explored alternative investments such as unlisted infrastructure.
That’s been a great call: unlisted infrastructure has consistently outperformed listed markets since the GFC. It’s delivered the elixir of equity-like total returns with lower volatility.
But the question now facing advisers is whether that strong run in unlisted infrastructure is over? Does the asset class still have a place in your client’s portfolio?
We think that, while many large, high profile or “trophy” assets are fully priced, there is still value to be found, particularly in mid-sized growth assets.
For yield investors, local social infrastructure investments in Public Private Partnerships (PPP’s) offer attractive absolute returns, particularly in comparison to comparable overseas investments and bonds.
For smaller investors, access and the illiquid nature of unlisted infrastructure assets has traditionally been an issue. More recently however, innovative products now provide easy access to the asset class coupled with liquidity.
Lower for longer, and longer
Investment returns are ultimately linked to economic growth and investment in capital assets is a key driver of growth.
In the developed world, capital investment and growth have languished. The availability of capital has not been the issue. Aggressive quantitative easing, and other stimulatory measures, have left developed economies awash in liquidity. However, very little of it appears to be invested into growth generating capital assets. Data from the US Bureau of Labour Statistics suggests that the required return on investment for capital assets in the US is now at its highest level in 75 years.
Policy makers face a dilemma. A winding back of stimulation may threaten the few economic green shoots. So, in the absence of a marked shift in policy making, we anticipate that this low-growth situation is likely to persist for the foreseeable future.
Consequently, investors are facing a ‘lower for longer’ environment: that is, low returns are likely to persist for the foreseeable future.
A tailwind for unlisted infrastructure
While many countries around the world remain biased to further easing of bond rates, some countries, notably the U.S., are looking to increase rates. This raises the question of what impact increasing bond rates may have on unlisted infrastructure valuations.
While bond rates are an important determinant of discount rates used in unlisted infrastructure valuations, valuers have tended to increase risk premiums as bond rates have declined. Consequently, discount rates have not fallen as far as bond rate movements would suggest, meaning that current valuations have an in-built buffer against future bond rate increases.
We anticipate the valuers will gradually wind back risk premiums in response to transactional information which confirms that long term investors accept “lower for longer” as the new status quo.
This has two important implications:
- Unlisted infrastructure valuations lag listed markets. This leads to low correlations with listed assets, providing diversification benefits to portfolios;
- A continued ‘lower for longer’ return environment is likely to see further unlisted infrastructure valuation growth.
So when it comes to specific unlisted infrastructure opportunities where should you be steering your clients?
While lower overall economic growth is implicit in the “lower for longer” scenario, there are still areas which will outperform. For example, Australian GDP growth is among the highest in the OECD. Additionally, the valuations of some Australian infrastructure assets, such as airports and student accommodation are leveraged to even higher growth rates in the Asia Pacific region.
We have already witnessed solid demand for very large Australian infrastructure trophy assets which has driven prices higher. But mid-sized growth assets haven’t experienced the same intensity of demand, and therefore offer investors better value.
Similar mid-sized opportunities are available in a range of other countries as well.
Social Public Private Partnerships (‘PPPs’) offering attractive yields
Another area we like is Australian social infrastructure. Social infrastructure includes a broad range of assets including schools, hospitals, car parks and convention centres.
State Governments are increasingly using PPPs to deliver social infrastructure. They’re paying private companies for the public use (‘availability’) of infrastructure. But State Governments are taking on ‘demand risk’ - the risk that few people will actually use, and pay to use, the infrastructure.
Given the high credit quality of the counterparties (often the State Governments), many investors consider mature, operational social PPPs to be good bond proxies.
For investors targeting yield, Australian social infrastructure PPPs are particularly attractive since yields are high relative to current bond rates.
Planes, trains and electricity
We also expect ongoing opportunities both in Australia and overseas in ports, roads and rail PPP’s, and in renewable energy.
While the economic benefits of privatising government services are clear, many overseas governments see the political risk of privatisations as too high. Subsequently, Australia still offers the greatest opportunity for future privatisations.
The further privatisation of large electricity distributors is still on the agenda. In addition, a number of mid-sized privatisations are in the pipeline, including data centres and other administrative operations.
Innovation: a threat and opportunity
Infrastructure suggests stability, but even it faces challenge from disruptive technologies that could impact established infrastructure models.
Already, homes can now replace expensive peak electricity local, green solar-generated energy. That takes the load off existing networks and could cut the need for new network investment, putting the 100-year-old electricity utility model at risk.
Electric cars will also have a major impact on road infrastructure, requiring large-scale charging facilities. In the longer-term, autonomous vehicles offer the prospect of much higher vehicle utilisation than the current “two cars for every family” model. In the future fleets of investor owned vehicle may blur the line between public and private transport.
A compelling asset class
Overall, in a world of low returns and lower interest rates, unlisted infrastructure remains a compelling asset class for investors seeking reasonable returns with relatively low volatility that are uncorrelated with equities.
For more information download our white paper on direct infrastructure here.
Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make 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 document 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 document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.