Building income with infrastructure

A growing number of Australian investors are directing capital into listed infrastructure stocks and funds with exposures to global infrastructure assets as a means of generating secure and stable cash flow.

And 2019 is seen by sector experts as likely to be another strong year for infrastructure assets globally, with low funding costs for project constructions and strong buy-out demand for listed assets creating good conditions for growth.

In addition, more self-managed super funds and private investors are being attracted to regulated infrastructure assets such as airports, toll roads, utilities including electricity, gas and water companies, as well as ports and railway networks as a means of tapping into regular income streams.

These are typically privatised assets, sold off by either national governments in Australia and overseas, or by state governments and territories.

The attraction is that infrastructure assets provide investors with relatively predictable and stable cash flows over the long term, which due to contractual arrangements are often set to rise in line with inflation. As such, these types of assets are less prone to broader market volatility.

Investors in listed investments, rather than unlisted, generally benefit from:

• Good diversity: If an investor is gaining exposure through a fund of listed equities, they will be gaining exposure to a diverse stock portfolio covering different sectors and demographics.
• Assets liquidity: The listed sector has a short time to invest or divest shares compared with unlisted funds, which can face potential problems when trying to liquidate their holdings, although some funds have sufficient capital inflows to meet withdrawal demands.
• Less acquisition risk: Direct investment needs intense due diligence, requiring a much larger team, and ultimately leads to greater portfolio concentration risk and limits the investor type.
• Greater in-cycle volatility: As listed assets are re-priced daily, there is higher in-cycle volatility. However, this can present opportunities for active investors to take advantage of market volatility.

Shane Hurst, senior investment analyst and portfolio manager, value and income strategies at RARE Infrastructure (part of the Legg Mason group), said returns to investors from infrastructure have been very strong and he expects that trend to continue through 2019.

“The cost of funding for a lot of these vehicles and a lot of these assets is very attractive, and so investment in utilities and infrastructure stocks will be going in a very positive and a corrective way,” Hurst said.

“So that will mean that certainly, if you look at your developed markets, you continue to see very strong growth out of utilities and pipelines there.”

RARE is globally diversified, with approximate infrastructure positions in North America (40 per cent), Europe (30 per cent), Asia-Pacific (18 per cent) and emerging markets (11 per cent).

North American pipelines have driven very strong investor returns over recent times, with investors re-rating a number of sold-down listed stocks in light of revised earnings forecasts.

Hurst also points to the sale of listed infrastructure assets generating strong above-market returns.

“You’re seeing a very strong theme come through for a lot of the listed infrastructure names where they’re selling assets to unlisted parties who are willing to pay much higher multiples than what is being intrinsically valued in those listed companies.

“So that is really important because it shows the disconnect between listed and unlisted markets, essentially saying listed markets are cheaper than the assets they’re selling to unlisted investors.”

Hurst says infrastructure funding will remain attractive in 2019, and that asset-based growth will be strong.

“So we’ll continue to run our very diversified portfolio to deliver the income strategy; that 5 per cent target dividend yield through each cycle and a total return of 9 to 10 per cent.

“If you look at our performance in the income strategy over the last three years we delivered a 12.6 per cent per annum return from our Australian vehicle. Over the five years we have delivered 9.2 per cent, so generally that’s where we target.”

Hurst says there are examples around the world where there is good value in infrastructure assets, with emerging markets strong contributors to its overall investment strategy last year.

“Brazil and China actually contributed pretty nicely and we’ve been investing in emerging markets since 2008, so we have a track record of doing that.

“There a number of areas that actually performed very, very well and one still sees some great opportunities there in the markets in 2019. Certainly in North America and developed markets as well as the emerging markets.”

Investors should consider adding infrastructure assets to their portfolio as part of a broader diversification strategy.