Model portfolios: Infrastructure securities

Australia’s love affair with property is hardly a secret. TV shows like The Block attest to that. But there’s another asset class that offers the security of bricks and mortar (as well as poles, wires and bitumen) and that’s infrastructure.

Let’s consider the case for infrastructure and then examine the alternatives we have as investors to get some diversified exposure.

Five reasons to invest in infrastructure

You can find plenty of literature discussing the social and political factors driving infrastructure spending globally but we’re more interested in it from the perspective of investors.

The attractions of infrastructure can be summarised in five key points:

1. High barriers to entry. Anyone can build a house, hotel or office block. Airports and toll roads are a different story. Many infrastructure investments are quasi-monopolies or actually government-licensed monopolies, meaning they typically face little or no direct competition.
    
2. Stable cash flows. Such monopoly assets are typically regulated so as to cap profits (rather than impose losses). This, combined with the typically essential nature of the services being offered, means the revenues of infrastructure businesses tend to be very stable. Further, they often have low operating costs, making their cash flows highly predictable compared to other businesses.
    
3. Inelastic demand. People tend to whinge about their road tolls or airport charges and then keep paying them. Economists call this an ‘inelastic demand curve’. If the peak toll on Sydney’s harbour bridge rose by 10% tomorrow, there would be virtually no change in the number of vehicles using it. But how many customers would your local petrol station have if it raised prices by just 5% tomorrow and its nearest competitors didn’t? For investors, inelastic demand equals generally stable cash flows with low risk.
    
4. Long-life real assets. Assets such as toll roads, airports, railways, mobile phone towers and electricity transmission networks have very long useful lives. This adds to their predictability.
    
5. Inherent growth. Use of infrastructure assets tends to increase with underlying population growth. Plus the revenue streams are often directly, or indirectly, linked to inflation. Both characteristics provide the type of ‘boring growth’ that’s attractive when looking for defensive assets.

All up, it’s a pretty boring investment proposition and that’s exactly why it will form a key part of the ‘property and infrastructure’ allocation of our model portfolios. The property and infrastructure component is intended to be defensive – more consistent and immune from economic cycles – so boring suits us to a tee.

Before you mistake us for unabashed fans of the asset class, a couple of caveats. The first is that although these assets are wonderfully low risk, their financing is often quite aggressive.

A decade ago, investment bankers got in the ear of many infrastructure groups (or even came to manage such assets themselves) and convinced them that steady cash flows equated to an almost limitless ability to borrow money. And borrowed money always introduces an element of risk.

On a somewhat related note, their predictable cash flows mean the price of infrastructure assets or groups behaves like a bond. When interest rates fall, they become more valuable and vice versa. It’s a risk worth bearing in mind at this point in the economic cycle while global interest rates are on the floor.

Investing in infrastructure

There are a few ASX-listed infrastructure stocks, including Sydney Airport (ASX Code: SYD) in which our model portfolios are already invested. But the infrastructure investing choices in Australia are limited. Investing globally offers better diversification and far greater opportunities.

Our basic tenet is that once we go international, we’ll turn to managed funds. As we explained in Model portfolios: International shares, most of us don’t have the time, expertise or resources to directly manage an international portfolio.

There are a number of global infrastructure funds easily available to Australian investors. They include offerings from Magellan, Macquarie, RARE, AMP Capital, Mercer and Russell.

Our pick is Colonial First State Wholesale Global Listed Infrastructure Securities Fund (Colonial), which we’ll add to each of our model portfolios (more detail below). This will form our core infrastructure holding, though we’ll keep an eye out for ASX-listed infrastructure securities with the aid of research from our colleagues at Share Advisor.

Ideally we’d spread our investment across multiple managers but that’s not practical due to the small allocation to property and infrastructure as an asset class combined with the minimum investment sizes of the funds.

We’re not too concerned, though. Colonial has had consistent performance, runs a global portfolio and the small size of the allocation means some under-performance isn’t going to cause too much damage to our overall results. Plus it hedges its currency exposure back to Aussie dollars.

Colonial First State Wholesale Global Listed Infrastructure Securities

Colonial has tended to stick to the more traditional infrastructure investments like toll roads, airports, electricity generation and transmission. And the fund has outperformed its benchmark consistently (not in short bursts).

Another great feature of this fund is that it offers a low minimum investment size – $5,000 – for its wholesale offering. Many funds deny access to smaller investors by making their minimum investment sizes $20,000 to $50,000, so we applaud Colonial for this feature.

Table 1 shows the shareholdings of the fund at 31 May 2013. This highlights the diversity available through investing globally and the difficulty Australian investors would have building a global infrastructure portfolio directly. Table 2 shows the fund’s key data and performance figures.

Table 3 sets out the amounts each of our model portfolios is allocating to this fund. This leaves our Property and Infrastructure asset class fairly full on infrastructure but we’re not too hung up on the distinction between ‘property’ and ‘infrastructure’. As long as we’ve got a reasonable allocation to each we’ll be guided more by opportunity.

An alternative option

Another option, especially for those who’d prefer to spread their investments across fund managers, is one of two multi-manager funds. These are the Russell Global Listed Infrastructure Fund (run by Russell Investment Management) and Mercer Global Listed Infrastructure Fund (run by Mercer Investments (Australia)), each of which include a 40% allocation to Colonial.

The Mercer fund (which invests in funds managed by Colonial, Magellan and RARE) sets its minimum investment at $100,000, so it’s only an option if your portfolio is large. But the Russell fund can be invested in through RussellIQ, which has a minimum initial investment of $20,000. In addition to the 40% allocation to Colonial, the remainder is invested by well-established global managers Cohen & Steers and Nuveen.

Investing through a multi-manager fund introduces the risk of a change of manager and less connection with the manager, so we’ve decided to stick with Colonial. But if you really want to diversify across managers, the Russell fund is worthy of consideration.

Final comments

We’re fans of infrastructure, although there’s some downside risk if interest rates rise unexpectedly. But we’re comfortable our portfolios – with substantial cash and little in the way of long-term fixed interest – are well positioned on this risk overall.