Listed or direct infrastructure - why not both?
Listed and direct infrastructure equities can exhibit differing returns, volatilities and correlations. It’s important for self-managed super fund (SMSF) investors to understand how these asset classes perform relative to each other in a portfolio, focusing on the investment opportunities within each.
Listed and direct infrastructure assets that are located in the same economy will behave similarly to changes in the commercial environment. However, valuations and returns between listed and direct assets may not always move in sync.
Listed valuations tend to respond more rapidly to, and are influenced by, general market sentiment, which results in higher relative volatility. In contrast direct asset valuation cycles are typically bi-annual with fewer unlisted comparative transactions. Additionally, 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 decays, the decline in the value of listed infrastructure assets tends to be faster and more pronounced than for direct infrastructure assets, 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 in investment portfolios.
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.
Investment opportunities – direct infrastructure
AMP Capital expects there will be some improvement in unlisted asset availability in the coming years. This will be driven by asset recycling from infrastructure funds, largely in Europe. Another important source of new supply will come from privatisations, particularly in Australia, for instance electricity and port assets, and possibly in Japanese airport assets.
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 demand from institutions and pension funds for these assets will continue to exceed supply for the foreseeable future, creating persistent upward pressure on asset prices. 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
AMP Capital’s view is that a ‘lower for longer’ yield environment will persist globally, and the US Federal Reserve will be cautious in lifting interest rates, given generally weak global growth. In this environment, continued strong demand is expected for real assets that offer high and sustainable yields.
While market volatility characterised the start of 2016, this has created interesting opportunities for dedicated infrastructure equity managers. AMP Capital is focused on identifying companies that have been unfairly impacted by general market sentiment and whose fundamentals haven’t changed.
For instance, there are standout investment opportunities emerging in North American infrastructure energy pipelines. Share prices for energy pipeline companies have fallen significantly, but the underlying fundamentals of many of these assets remain intact. Companies in this sector that don’t need to access capital markets, have limited counterparty risk and secure contracts in place are attractive investments.
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 and using the proceeds to reinvest back into exploration. An example is oil and gas exploration companies listing their pipelines and gas processing plants.
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 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 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 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 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 differing approaches can make comparability a challenge. The general characteristics of infrastructure – both listed and direct – serve to diversify portfolio risk and can be complementary. So a holistic approach may help meet investor needs.
About the author
John Julian is an Investment Director in AMP Capital's Global Infrastructure team, and the portfolio Manager of the AMP Capital Core Infrastructure Fund. He has over 23 years financial sector and investment experience in both commercial and legal roles.
Tim Humphreys is the head of AMP Capital’s Global Listed Infrastructure team, based in the Sydney office. He also leads the research effort of infrastructure companies in the Americas. Tim has over 15 years’ experience in the financial industry in the UK and Australia and is a skilled infrastructure analyst.