Global listed infrastructure: not just a bond proxy
Global listed infrastructure has become an increasingly attractive asset class for self-managed super fund (SMSF) investors for its diversification and other benefits.
SMSF investors who are already invested in infrastructure, or thinking about it, would do well to understand its relative performance to other asset classes, in the context of a rising interest rate environment.
Global listed infrastructure versus government bond yields: financial markets perspective
Government bond yields started rising shortly after the UK’s Brexit referendum in June 2016 in response to higher inflation expectations in the UK and to a lesser extent in the US, Europe and Asia. Higher commodity prices have been the main catalyst for this.
In our view, US President Donald Trump’s election in November 2016 also caused US bond yields to rise, as markets began to focus on the implications of pro-growth policies aimed at boosting the US economy. The increase in US nominal interest rates also contributed to the rise in government bond yields globally.
Interest rates have risen in a material way four times since the end of the financial crisis of 2007/2008, often in response to central banks’ use of unconventional monetary policies.
In each of these periods nominal and real sovereign yields have risen, global equities have performed strongly and global listed infrastructure has underperformed on a relative basis.
However, global listed infrastructure has tended to make up the relative underperformance to global equities in the 12 months after periods when nominal yields have risen.
Aside from normalisation of interest rates, investor recognition of the asset class’s long-term, stable cash flows is a reason why we expect global listed infrastructure performance has improved on a relative basis to global equities.
Global listed infrastructure versus government bond yields: sector diversification
Global listed infrastructure is a diversified asset class, with exposure to a wide range of sectors around the world.
Regulatory frameworks and contract structures vary greatly across sectors and regions. This diversification is an attractive characteristic of the asset class and helps to protect SMSF portfolios when economic conditions are volatile.
Given global infrastructure’s wide variety of assets and regulatory frameworks, there’s been a divergence in returns from different investments in the class since the financial crisis.
Below are three takeaways for global infrastructure investors, in light of current market conditions:
1. Financial markets usually overreact to increases in government bond yields, which can lead to a short-term drop in the value of global listed infrastructure securities.
During periods when interest rates have risen since the financial crisis, global listed infrastructure has generally underperformed global equities. But the asset class recovered all relative underperformance in the 12 months following these periods on all but one occasion. In our view, this demonstrates how markets overreact to a rising yields environment.
Taking a longer-term approach, we believe the strong correlation between the performance of the asset class and its cash flow growth supports the view investors should focus on the underlying assets and their ability to generate visible and growing cash flows.
2. Rising yields should be taken into consideration in the context of global listed infrastructure’s diversification.
Given its differentiated nature and global footprint, the impact of economic variables such as interest rates, is not the same across all global listed infrastructure’s sectors.
As characteristics like regulatory frameworks and exposure to growth differ across industries and regions, it is not surprising that assets tend to perform quite differently during periods of rising government bond yields.
By investing in a truly diversified portfolio of listed infrastructure companies, we believe investors can mitigate risk arising from factors such as interest rate movements.
Moreover, we expect that equity market volatility from short-term interest rates hikes can present an opportunity for investors to profit from the resulting dislocation of value and price across the universe of global infrastructure assets.
3. Differentiating between nominal and real yields is crucial to understand the impact of interest rates on global listed infrastructure cash flow and valuation.
Due to the asset class’s long duration, as well as diverse regulatory frameworks and contract structures, global listed infrastructure companies’ cash flow and valuations can be impacted differently depending on changes in real yields and/or inflation expectations.
Given recent volatility in global bond markets, we believe it is important to differentiate the impact of various nominal and real interest rate scenarios on the asset class to provide a framework for portfolio construction and asset allocation.
Overall, we believe global listed infrastructure assets provide a meaningful way for SMSF investors to access the benefits of this asset class, for instance the potential for good returns over time. In our view, the idea is to focus on quality assets and keep an eye on short-term market movements to reduce investment risks.
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) makes no representation or warranty 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.