Investing in a solid foundation: infrastructure
April 28 2010James Dunn | From: The Australian | April 28, 2010 12:00AM
INVESTORS should be looking at infrastructure for one very good reason: it is where the growth is.
Globally, according to Canadian Imperial Bank of Commerce World Markets, $US35 trillion will be spent on infrastructure over the next 20 years.
The Organisation for Economic Co-operation and Development puts the figure at $US41 trillion — but its timescale for that investment is 2005-2030. And while most people would assume the burgeoning growth of the emerging markets is behind this surge — with China’s mind-boggling infrastructure statistics at its heart — that is not wholly the case. The OECD’s figures have the infrastructure spend in North America and Europe at $US15.6 trillion, almost matching the $US15.8 trillion slated to come out of Asia/Oceania.
“That’s the beauty of infrastructure as an investment theme,” says Andrew Cassar, senior investment analyst at Zenith Investment Partners. “The attraction is not just the massive amounts of spending projected to build infrastructure in the emerging markets, but also the similar size of spending that the developed world has to do, to refurbish and upgrade existing infrastructure.”
A case in point is that while China plans to spend $US128 billion on water-related investments by 2014, the US requires $US1 trillion in water infrastructure investment over the next 20 years.
Cassar says global infrastructure securities funds, which invest in listed infrastructure stocks around the world, are the best way for a retail investor to hold infrastructure in their portfolio in a properly diversified way. “We view global listed infrastructure as a lower-risk international shares option [relative to the MSCI World Index] in a well-diversified portfolio.”
The professional managers are best-placed to choose an infrastructure portfolio, he says. “In infrastructure it’s very important to get a broad range of exposures across the different kinds of infrastructure assets. For example, you’ve got `regulated assets’ [eg. water and sewerage utilities, distribution pipelines and transmission wires], `user pay’ assets [eg. toll roads, airports, ports and railways] and `competitive assets’ [communications, power generation and energy providers]. “The appropriate weightings of these kinds of assets depends very much on the economic cycle. For example, defensive assets like utilities come into their own when economic growth is flat, but user-pay assets will generally outperform utilities in periods of strong growth,” he says.
Zenith has a `highly recommended’ rating on the RARE Infrastructure Value Fund, and a `recommended’ rating to four others, the CFS Global Listed Infrastructure Securities Fund, the Macquarie International Infrastructure Securities Fund, the Magellan Infrastructure Fund and the RARE Series Emerging Markets Fund. These five funds have annual fees of 1-1.3 per cent of invested assets), with all except the CFS fund also having a performance fee.
Cassar says infrastructure should be in the portfolio as a defensive/income asset. “Infrastructure is not Australian equities where you’re going to get 8-10 per cent a year. It’s not meant to be a high-octane security, it’s meant to generate a consistent capital growth return of 3 per cent a year, plus income of 3-5 per cent.
“In some cases it has been considered as an inflation-protected defensive hedge against down markets — but as we saw in 2008, nothing really was a defensive position, everything correlated with everything else, and no asset was considered a defensive asset, infrastructure included. We would say that investors should view infrastructure as what it was always supposed to be: a stable, defensive, long-term cashflow generator,” says Cassar.
Asset manager Goldman Sachs JBWere Asset Management says the strong case for a significant allocation to Australian infrastructure within a balanced portfolio is based on the following attributes: high level of earnings certainty; the inherent inflation hedge, which protects purchasing power for long-term superannuation investors; the consistent and attractive, tax-efficient yield; the diversification benefits (low correlation with other major asset classes); and the strong growth expected in infrastructure investment by both the private and public sectors.
Goldman Sachs JBWere Asset Management says the earnings certainty comes mainly from the monopoly positions in markets — either from natural monopoly characteristics where the economies of scale make it irrational to replicate existing infrastructure (such as in airports or transmission lines), or through contracts/concessions (such as an exclusive right to operate a tollroad).
Second, says the firm, infrastructure assets show inelastic demand — that is, because they provide essential services such as providing power, transport and water, demand is very stable and tends to grow with time. Goldman Sachs JBWere Asset Management says the combination of these two features provides infrastructure assets with significant pricing power; earnings can continue to grow even in the infrequent circumstances where volumes contract.
As the asset manager points out, Australian infrastructure assets look very attractive to long-term investors, in particular overseas pension funds. That is evident from the raid by the Canadian Pension Plan Investment Board, which bought out Macquarie Communications Infrastructure Group in June 2009; and the Canadian institution’s second foray to the Australian Securities Exchange (ASX) in November 2009, in conjunction with compatriot Ontario Teachers’ Pension Plan, with a $6.8bn bid for tollroad operator Transurban, of which the pair already owned 28 per cent. Transurban immediately rejected the offer, saying it undervalued its assets.
In December 2009, Australia’s sovereign wealth fund, the Future Fund, announced that it was talking to the Canadian funds about supporting their proposal, but it ended those talks last month. Andrew Chambers, infrastructure analyst at Austock Securities, says the Canadian pair would probably have to lift their bid from $5.25 a stapled security to $6 to be successful — but adds that on a one-to-two-year view, Transurban is likely to be above that price regardless of the current takeover offer.
For their part, Australian superannuation funds are interested in infrastructure, because the steady long-term cash flows it provides suit their needs. In particular, says Alex Dunnin, head of research at research group Rainmaker Information, industry super funds have been much keener on investing in alternative assets — a category that includes infrastructure, private equity and hedge funds — and typically have 18 per cent of their investments in with about half of this allocation in infrastructure. In comparison, he says, retail master trusts on average have 4 per cent allocated to these types of assets and only very low exposure to infrastructure.
The biggest super funds in terms of infrastructure allocations are mainly industry funds: MTAA Super has $1.5bn (28 per cent of its assets) in infrastructure, CBUS has $1.6bn (12 per cent of assets), Australian Super has $1.8bn (6 per cent of assets) and UniSuper has $1.5bn (4 per cent of assets). New South Wales government employees’ super fund State Super NSW has the largest funds allocation to infrastructure in dollar terms, at $2.2bn invested, or 7 per cent of assets.
MTAA Super has been investing in infrastructure for more than 12 years. Dunnin says the major reason for its very high allocation is that the fund uses infrastructure as its “de facto fixed interest allocation” because infrastructure has almost all of the characteristics of bonds.
Chris Trevillyan, senior consultant and head of infrastructure research at Frontier Investment Consulting, says infrastructure should not be viewed as a straight bond replacement, because it has more risk than bonds.3
But he says this means that super funds can expect a premium for owning it. “These are generally operational assets, and even with regulated assets you can still get volatility in the cashflows from time to time, so it’s not a direct substitute for fixed-income. But that risk gives it a touch of growth. At a very minimum we see infrastructure earning 4 per cent above long-dated bonds — so at current rates, you’re looking at 10-11 per cent as a return expectation. That’s a minimum hurdle rate of return, and then if you introduce development risk, or more exposure to GDP growth you’re looking for an additional premium,” he says.
But while super funds are attracted to infrastructure, they are wary of how best to enter it. Spectacles such as UniSuper blowing up $50m on infrastructure investments in NextGen fibre optic cabling and Loy Yang Power, and toll-roads going into receivership because not enough vehicles used them, have made them gunshy — not to mention their experiences in the GFC. However, they are more than willing to do it: UniSuper, for example, is involved in the Victorian Government’s desalination plant project, as a bond holder.
And earlier this month, retail industry fund REST joined with the UBS International Infrastructure Fund to buy the Collgar wind farm in Western Australia.
“Super funds are still certainly looking for infrastructure investments: it’s just that they’ve now got a much better understanding of illiquidity,” says Trevillyan. “Our clients typically have up to 10 per cent allocations to infrastructure. Nearly all would prefer to be doing it in the unlisted space: the smaller funds are going through wholesale funds, but the larger funds are looking more direct.
“A lot of that’s more to do with being able to have control of the overall portfolio, and what they’re allocating into; they want to be able to manage their total portfolio and also hopefully have more input into the buy and sell decision.
Really, the funds are trying to get the best of both worlds: we certainly see infrastructure as playing a more defensive role in the portfolio, but with still some upside,” says Trevillyan.
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