The road to a predictable retirement

Infrastructure assets give baby boomers benefits not offered by other investments, writes John Collett.

Infrastructure assets give baby boomers benefits not offered by other investments, writes John Collett.

Investors wanting more income from their share portfolios in the face of continuing pessimism on global sharemarkets could find it in infrastructure.

Because infrastructure often has inflation-linked revenue, it is a good way for baby boomers to receive predictable income in retirement.

An investment analyst at researcher Zenith Investment Partners, Jonathan Baird, says a lot of Australian investors are not thinking much beyond Rio Tinto, BHP Billiton and the big four banks, but the performance of infrastructure investments can be much more predictable.

"If you have an airport where the contracts are locked in for extended periods, you can be pretty confident about what is going to happen," Baird says. "There would have to be a significant change to the economic environment for anything material to happen to those returns."

Fund managers say the financial crisis in Europe is presenting opportunities there as cash-strapped governments start selling infrastructure assets at a discount. Investing in infrastructure - water, gas, rail and roads - both in Australia and overseas, is also a good way of diversifying the equities component of a portfolio, Baird says.

Infrastructure and utility assets tend to have some common characteristics. They are usually essential services in which a price increase will not reduce demand, and they are often government regulated to provide a service at an approved price. They often also have high barriers to competition, such as regulations preventing a competing asset from being built nearby.

Infrastructure funds

For small investors, the best way to get a diversified spread of infrastructure investments is through a managed fund that invests in infrastructure companies listed on sharemarkets around the world.

Investment researcher Morningstar has just completed a review of managed funds that invest in listed global infrastructure shares and given two funds its second-highest silver rating (see box).

A senior research analyst at Morningstar, Tim Wong, says global listed infrastructure funds can help investors diversify their equity risk. He says historical returns show the funds have defensive qualities compared with other equities, meaning that when share prices fall, those of infrastructure companies don't fall as much.

The funds have typically delivered yields about two percentage points higher than global equities. However, expecting a certain income level to persist indefinitely is hazardous.

Wong says that when the Australian dollar plummeted in 2008, several funds failed to pay distributions that year because of the need to pay for currency-hedging loses. The promise of yields should not be an overwhelming reason for choosing the sector, he says. The performances of the infrastructure funds are affected by broader equity-market performances and can be volatile.

Wong says a fund's investment merits should be considered from a "total return" perspective, which consists of income and capital returns, not just the yield.

He says infrastructure should be used as part of an investment portfolio's global shares allocation, not as part of a purely defensive allocation. The two truly defensive asset classes remain fixed interest and cash, Wong says.

European opportunities

A co-founder and senior portfolio manager at global infrastructure manager RARE, Nick Langley, says the sale of infrastructure assets by European governments is providing opportunities for fund managers.

The governments of Poland and Portugal are selling some of their interests in electricity utilities, he says. And the Portuguese and Spanish government's want to sell some airports. But just as there are opportunities, there are also potential hazards, Langley says.

Some infrastructure companies loaded up on debt as banks were willing to lend on assets that were producing a steady income.

But that increases infrastructure companies' sensitivity to economic conditions, such as a recession, when it can become more expensive to refinance debt.

And in boom times, there can be a lot of mergers and acquisitions, where the prices paid appear expensive once the boom is over.

European governments are seeking to increase taxes on utilities and are taking steps to lower energy tariffs to help stimulate the economy, Langley says.

'Greenfield' riskier

Many Australian investors' experience with infrastructure will be through one or more of Macquarie's Australian sharemarket-listed infrastructure trusts.

While the investments made a lot of money for investors for many years - and still do - some of the trusts hit problems in the wake of the global financial crisis, when listed markets everywhere collapsed.

Macquarie's Australian sharemarket-listed tollways vehicle, Macquarie Infrastructure Group, held significant exposure to "greenfield", or new, tollway developments. Critics have argued that investors' interests and those of Macquarie were not always aligned.

Some of the trusts also had high levels of debt that were costly to refinance during the worst of the credit crunch.

Listed greenfield infrastructure assets are rare in the rest of the world, with most held in private-equity investment vehicles or in government hands.

Langley has strict limits on how much greenfield infrastructure to hold in the fund manager's portfolios. He says that generally, greenfield infrastructure should not be listed because there is too much risk in the early stages. "They should be built in private hands and later traded on listed markets," he says.

Jonathan Baird says it's important that fund managers have a conservative view of what is infrastructure. As an example of assets he considers to be risky, he cites Japanese electricity utilities, because "inadequate" regulation creates more-competitive markets. "Ultimately, they compete for sales on price," he says.

Infrastructure funds that rate

Morningstar has given two listed global infrastructure funds RARE Infrastructure Value Fund and Magellan Infrastructure Fund its second-highest rating of silver.

Two others, Colonial First State Global Listed Infrastructure Fund and Vanguard Global Infrastructure Fund, scored bronze.

None of the seven funds reviewed received a gold rating.

A Morningstar analyst, Tim Wong, says that is because, "none sufficiently excelled across all of the five basic areas we assess people, process, performance, parent and price".

RARE portfolio managers are willing to alter the portfolio dramatically when macroeconomic conditions change, Morningstar says.

In the second half of 2011, RARE decreased its weighting to Europe and emerging markets over concerns that markets were becoming risk adverse.

Magellan shifted to a more defensive 50/50 split between infrastructure and utilities following the 2008 crash.

Both funds produced above-average gains in 2011 thanks, in part, to these defensive moves, Morningstar says.

RARE and Magellan both have a recorded history of strong macroeconomic research and successful execution, fostering confidence that they can get their calls right more often than not, the researcher says.

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