RARE Infrastructure Limited

The Australian – Power, roads prove a class asset

Power, roads prove a class asset
Investors can move into utilities through diversified global managed funds, James Dunn reports

THERE is no question that Australian investors have embraced infrastructure as an asset class.

Six years ago, there was $2 billion in infrastructure funds listed on the Australian Stock Exchange(ASX).

That figure is now $39 billion, with heavyweights such as Macquarie Infrastructure Group, Transurban and Macquarie Airports ranked among the market’s largest stocks.

What has sparked this huge growth is the realisation that the massive fixed assets that provide services we rely on – such as electric power and gas generation and distribution facilities, sewerage and water systems, major road links and transportation and telecommunications installations – are used by virtually everyone, and they last a long time.

To investors, this means long-term, non-volatile cash flows.

“The major investment characteristics of infrastructure assets are predictable long-term cash flows, with high revenue certainty, which lends itself to gearing; relatively low risk and volatility; but high barriers to entry,” Zenith Investment Partners principal David Smythe says. “They are effectively a hedge against inflation. In fact infrastructure is often referred to as ‘an index-linked bond with growing face value’.”

Smythe says infrastructure assets share some of the characteristics of listed property securities – high yields and low correlation to equities – and their returns are also underpinned by real assets. As such, investors can allocate to infrastructure as part of their property allocation, or as part of their international shares portfolio.

“Infrastructure’s low correlation to traditional share investments and consistency of return patterns can help to protect an international shares portfolio return in bearish markets,” he says.

The thriving infrastructure sector on the stock market has been the major way that Australian investors have gained exposure to infrastructure.

Large Australian investment banks like Macquarie, and some of the nation’s superannuation funds (see breakout), have become active direct investors in the global infrastructure market. But just as in listed property, a “third way” has opened up for Australian investors to participate via an infrastructure securities fund.

Infrastructure securities funds are like equity funds: they offer investors access to a portfolio of infrastructure securities managed by professional fund managers, which allows the investor to achieve diversification across the sector with reduced portfolio risk.

Think of Macquarie Infrastructure Group, Transurban and Macquarie Airports as the infrastructure version of listed property trusts (LPT).

There are about 700 infrastructure stocks listed around the world, in a $2000 billion market – about twice the value of the entire Australian stock market. This is the universe in which infrastructure securities funds invest.

Lonsec Research senior investment analyst Paul Pavlidis says the emergence of infrastructure securities funds follows closely the pattern of the property securities funds, which arose to invest in LPTs.

“The way that the Australian LPTs developed, is that they outgrew Australia and began to invest overseas in their own right. Some of our listed infrastructure funds have done the same thing. But what the infrastructure securities funds offer is exactly what the property securities funds offer – far better diversification.

“The infrastructure securities fund manager will have anywhere between 30-80 infrastructure and utilities stocks from around the world which it has researched as having the best potential to outperform.”

As an asset class, Pavlidis says infrastructure is similar to property. That is, you get a stable yield return but you should also benefit from reasonable capital growth.

“Over the longer term we expect domestic listed infrastructure to deliver somewhere between 10-12 per cent a year, with global listed infrastructure returning a touch more.”

At present, five fund management groups offer infrastructure securities funds (see table) to Australian investors: Challenger, Goldman Sachs JB Were, Lazard, Macquarie and UBS.

In a further sign of the potential of the sector, the first boutique global infrastructure securities fund manager, RARE Infrastructure, opened for business in August and will soon be available to retail investors on platforms. RARE Infrastructure senior portfolio manager George Raftopulos says that the investment market is hungry for alternative exposures to global infrastructure, particularly in the listed arena. “Over the last 10 years, listed global infrastructure has delivered an average annual return of about 17 per cent. It has been very strong, and that has attracted the interest of a lot of
Australian investors.

“We don’t think that is sustainable in the general sense, but we believe that good managers will continue to pick superior stocks and generate superior returns. We’re finding that investors want the story of global infrastructure, the long-dated assets with resilient and predictable cash flows and attractive yields that represent an inflation hedge.

“And, in a global sense, they are more willing to look at the securities fund approach than going through just one listed Australian vehicle.”

By contrast, he says, investing in a fund gives investors exposure to a complete portfolio of airports, toll roads, utilities, satellites, on a global basis. They have the same liquidity as listed vehicles but with far more diversification.

“And that’s before the investor even considers the fee aspect: an investor going through a listed vehicle faces reasonably substantive fees which the manager takes off before you get the benefit of the underlying investments, and often a performance fee.

“In a global listed infrastructure securities fund, no manager would get away with charging more than 100 basis points (1 per cent) to manage the money.”

Raftopulos says the absolute-return focus of newcomer RARE Infrastructure is also attracting interest.

“Most of our competitors benchmark their return against an index, but if you look at the composition of the major global infrastructure indices, they are comprised nearly 80 per cent of US stocks. We don’t think that gives the investor adequate balance.”

In the developing markets – for example, Brazil, China, Mexico – there are some very high-quality assets, he says. “Invariably there is a lot of risk associated with going into these countries, and we temper it by needing a much higher hurdle rate of return from the assets.

“But what gives us comfort is that in many cases a lot of these projects are co-owned by major European players.

“For example, you’ll see Brisa, which is a big player in toll roads in Europe, in joint ventures in toll roads in Brazil.” Whereas some investors, for example superannuation funds (see breakout) still prefer direct infrastructure investments because of the lack of share market volatility, Raftopulos says the equity volatility of the underlying investments of an infrastructure securities fund is not a great issue – “not when set against the valuation efficiencies and liquidity that being listed brings. For example, we own Airports de Paris, which runs Charles de Gaulle and Orly airports in France. The government still owns two-thirds of this company but, in time, we expect the government to sell down, and as that happens, you can anticipate that the capacity of the professional management to be more efficient will improve”.

The beauty of the global infrastructure securities space, he says, is the sheer number of assets like Airports de Paris coming through. That is, there is scope for efficiencies to be extracted from the existing asset.