Listed Infrastructure
the power of compounding
While equity markets have enjoyed a strong rally since last September, fears that the UK is facing several years of sub-trend economic growth have gathered momentum in recent months. Ominously for savers in this “Lower for Longer” environment, interest rates are set to remain at historically low levels for the foreseeable future.
In their influential book, This Time is Different,
which analysed eight centuries of crises,
Carmen Reinhart and Kenneth Rogoff found
that typically economies experienced lower
growth for a decade after the onset of a crisis;
this would suggest that maybe we are not
even a half way through the recovery phase.
Against such a backdrop, an asset class such as
infrastructure which offers investors an attractive,
sustainable and secure dividend yield has obvious
attractions.Infrastructure is defined as the structures needed for the operation of a society, or the services and facilities necessary for an economy to function. These include economic assets such as transportation, utilities and communications and social assets such as health and education. Historically the responsibility of governments, the sheer extent of the global funding requirement for new and replacement assets (the OECD estimates $53 trillion by 2030), the current state of public sector balance sheets, and a desire to obtain better value for money for taxpayers has seen a greater involvement by the private sector. The private sector entity may or may not be contracted to construct the asset, and it will be responsible for financing and the operation of the asset for a long period of time, typically 20-30 years.
Notwithstanding extreme turbulence in global financial markets in recent years, the Listed Infrastructure sector has enjoyed strong growth since the launch of HICL Infrastructure in March 2006. The aggregate market capitalisation of the five mainstream infrastructure funds – 3i Infrastructure, Bilfinger Berger Global Infrastructure, HICL Infrastructure, International Public Partnerships and John Laing Infrastructure - now stands at £3.2bn. Given the increased recognition of the attractions of this evolving asset class and the strong demand for attractive and sustainable income streams and healthy investment pipelines, this robust growth dynamic looks well entrenched.
The Listed Infrastructure companies offer investors a range of exposures in terms of investment status (operational assets vs. higher risk/higher return assets in construction and also availability vs. more economically sensitive demand based), geographic exposure and underlying risk/return profiles. At the low end of the risk spectrum, HICL Infrastructure and John Laing Infrastructure have long-term target returns of 7-8%. Bilfinger Berger Global Infrastructure and International Public Partnerships give investors more capital growth potential, albeit with higher risk profiles and further along the risk spectrum, 3i Infrastructure has a long-term target return of 12%.
The strong growth experienced in recent years has been underpinned by an attractive dividend yield; the weighted average dividend yield is now 5.2%, comfortably higher than the FTSE All Share yield of 3.2%. Progressive dividends have been a feature and we would highlight that these are fully covered from cash-flows, the majority of which are index-linked. The underlying assets deliver stable and predictable cash-flows and with the majority of income streams underpinned by long-term availability-based concessions with the public sector, these dividends appear secure. In addition to dividend growth, the sector offers varying degrees of capital growth potential although given there is no such thing as a free lunch, investors must be aware of the impact of these on underlying risk profiles.
The listed infrastructure sector has delivered superior riskadjusted returns and has an important role to play in improving portfolio diversification. Since March 2006, the annualised price total return of the listed infrastructure sector is 9.3% compared to a compound FTSE All Share total return of 3.6%. At a time when correlations between most asset classes are at historically high levels, returns from the infrastructure sector continue to demonstrate low correlation with other asset classes. In a report at the end of last year we found that the long term correlation with equities was just 0.3. In addition, as demonstrated in the chart (price total return vs. volatility), price volatility has been much lower than quoted equities.
Infrastructure returns have shown low correlations with the underlying economic performance and the sector has capital preservation characteristics. This was highlighted during the sharp fall in global equities in Q3 2011; when the FTSE All Share fell 19%, the Listed Infrastructure sector fell just 5.5%.
In just a short period of time, the listed infrastructure sector has already achieved critical mass. Notably, the illiquidity of the underlying assets means the open-ended structure is not appropriate for gaining exposure to this asset class. The infrastructure companies are now amongst the most marketable in the entire investment trust sector and low bid-offer spreads have been a consistent feature - this reflects a sector in rude health.
Warren Buffett has often spoken about the power of compounding in generating superior long term returns. As the chart demonstrates (Listed Infrastructure vs. FTSE All Share), the compounding of solid absolute returns has resulted in strong outperformance by listed infrastructure companies over quoted equities. Given their attractive, secure and sustainable dividend yields, superior risk adjusted total returns and their role in improving portfolio diversification, the listed infrastructure sector has undoubted strategic value for investors, many of whom now regard them as cornerstone investments within a diversified portfolio. Additionally, given many well documented headwinds facing financial markets and for investors expecting further volatility in the coming months, the listed infrastructure companies also have capital preservation qualities which should have appeal to the more cautious tactical investor.
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