Infrastructure like roads, rail, airports and utilities are part of our daily lives and drive global economic growth and productivity. As an asset class, infrastructure is uniquely positioned to perform in a wide range of market conditions, underpinned by regulated real assets with revenue linked to future inflation.
Historically, listed infrastructure has delivered strong, consistent risk-adjusted returns and important diversification benefits, which are critical in today’s increasingly uncertain and volatile economic environment. Chief investment officer Justin McLaughlin examines the case for listed infrastructure in a diversified portfolio.
Listed infrastructure deserves a place in a diversified portfolio for a variety of reasons.
Putting aside the sector’s consistent long-term outperformance, an allocation to listed infrastructure provides diversification benefits and gives ordinary investors the opportunity to own and financially benefit from substantial and secure real assets like roads, rail, telecommunications and other utilities.
These assets are an essential part of our everyday lives and underpin global economic growth and productivity.
As such, infrastructure has historically been a source of relatively stable returns. Importantly, those returns have a low correlation to traditional assets like shares.
What that means is that when equity markets tumble, defensive assets like infrastructure tend to shine, falling less than equities.
On the flipside, when equities run hot, as they have in the past six months off the back of a rally in US equities following President Donald Trump’s election, defensive assets typically appreciate but at a lesser pace than equities.
The benefit of holding a diversified portfolio of assets that are lowly- or negatively-correlated to one another is that it reduces overall risk and volatility, smoothing out returns over time.
Short-termism and listed infrastructure
The majority of professional fund managers aim to deliver solid risk-adjusted returns over the long-term but ironically, many are hindered by short-term performance targets.
Unfortunately, short-termism is too prevalent in funds management. This has the potential to derail sound, robust investment strategies and processes.
The challenge for managers who chase short-term outcomes is to resist the temptation to reduce their exposure to listed infrastructure or cut it altogether, given the sector’s recent drop off in performance.
Returns from listed infrastructure (unhedged), after fees and tax, were flat in the last six months; a time when Australian and global shares (unhedged) delivered 9.9 per cent and 9.8 per cent respectively.
Investors now face the challenge of ignoring the noise and holding fast to their long-term strategy.
The fundamental case for investing in infrastructure is unchanged but it’s important to remember the sector has delivered strong double digit growth for the past five years, outperforming Australian shares, bonds, cash and emerging markets.
Although it has underperformed global equities and listed property, infrastructure investors have still received attractive returns with lower levels of risk.
And that’s precisely the point.
Infrastructure can deliver solid returns but with significantly less risk than equities.
In the context of overpriced equity markets, especially US shares which are currently priced for perfection, this is critically important.
Right now, US equity valuations are stretched which raises the risks of investing in the US, especially given President Trump is an unknown and unpredictable quantity.
When shares are expensive, accidents are more likely to happen.
That’s why maintaining a meaningful exposure to infrastructure makes senses.
- It generally enables investors to participate in equity markets with some downside protection due to the regulated nature of “essential services” and their associated returns.
- Good active managers can adjust a portfolio to minimise exposure to sectors that act more like a “bond proxy”, such as regulated utilities, and increase exposure to assets exposed to economic growth, such as airports.
- Many infrastructure stocks are the ideal investment in an inflationary environment due to inflation-linked price increases.
- Valuations are not stretched in this sector and currently represent fair value.
- Bonds are too expensive and yields are unlikely to be going back to pre-GFC “normal” levels any time soon.
Our Dynamic model portfolios invest in a diversified mix of asset classes including listed infrastructure. The Dynamic 85 portfolio has returned 13.14 per cent per annum, for the five years to December 31, 2016; outperforming the Australia Fund Multi-sector Aggressive Index by 1.27 per cent with significantly lower levels of risk.
Listed infrastructure has been a significant contributor the strong performance of our funds and model portfolios.
Justin McLaughlin is Chief Investment Officer.