By John Julian, Investment Director, Infrastructure Equity at AMP Capital
The pros of investing in infrastructure
Global markets are yet to enter any serious downturns. Still, fragile growth outlooks, high levels of market volatility, record-low interest rates and myriad geopolitical and macroeconomic risks – not least of which is a trade war between the world’s two largest economies – will leave many wondering how they will meet their investment goals in the short to medium term.
The current investment environment is no doubt an uneasy one for many investors. Rather than wait for economic winds to change, investors could instead look to investment classes with outlooks that are less dependent on external and cyclical factors as some others. In this regard, infrastructure investment offers some compelling features in an uncertain climate.
What are some of the benefits of investing in infrastructure?
1. Consistent returns with lower volatility* through market cycles
Infrastructure assets are commonly “essential services” assets. This means people have to use them on a day-in and day-out basis. As a result, both utilisation and returns can often be less dependent on the prevailing economic climate than other investments. It is very hard for someone to get through a day without having to use some form (or forms) of essential infrastructure such as electricity, water, gas, schools, hospitals, roads, rail and airports.
In addition, infrastructure assets often benefit from significant barriers to entry in the markets in which they operate. They can have contractual protection from competition by government, while high costs and long lead times for construction provide natural monopolies, and give advance warning and further insurance against new competitive threats to existing revenue streams. For this reason, returns are often more reliable than those associated with comparable assets outside the sector.
2. Reliable long-term income yields
Infrastructure asset revenues are often underpinned by regulation or long-term contracts, which provide a high level of visibility of, and certainty around, future cash flows from the asset.
An example of this in practice occurs with Public Private Partnerships or ‘PPPs’, which are often used by governments to deliver infrastructure projects such as roads, hospitals, schools and public transport systems.
Concessions for assets such as these are often granted over lengthy contractual periods (which can be 30 years or more) and typically offer ‘availability’ revenues, which are paid on the basis that the asset is made available and maintained in a fit state for the intended use, irrespective of the extent to which it is actually used.
For example, in the case of a school of this type, so long as the asset is maintained in a fit state and made available for use, the asset owner gets paid a fixed amount irrespective of the number of students that are enrolled in the school.
Isolation from usage risk in this manner provides a unique level of visibility and security of future revenues from the asset, particularly given that the counterparty responsible for making the availability payments is often a highly creditworthy government body. In addition, infrastructure asset revenues are often linked to inflation, which can help investors protect against the erosion of the value of their investment by inflation over time.
3. Diversification and reduced overall portfolio risk
Overall portfolio diversification is improved when assets have a low level of correlation – that is, where assets don’t behave the same way at the same time. The infrastructure asset class, and unlisted infrastructure in particular, has historically demonstrated low levels of correlation with other asset classes, meaning its inclusion in a broader portfolio can be an effective means of reducing overall portfolio risk.
Infrastructure, and particularly unlisted infrastructure, displays low correlation with many other asset classes, making it another option for investors wishing to diversify their portfolio, and an attractive one given the historically strong returns.
Many investors have cottoned-on to the benefits of infrastructure, and we expect this to heighten. There is a significant need for new infrastructure in both developed and developing economies. With governments across the globe burdened with high levels of debt, fewer infrastructure projects are likely to be publicly funded. The need for private capital to replace ageing infrastructure or fund new projects will consequently persist over the long term, which we believe will support a broad and growing range of infrastructure investment opportunities.
* Volatility is a means of measuring investment risk. It is a probability measure of the standard deviation of expected returns, and hence can provide a useful comparative measure of the relative risk of different investments over a particular time period.
Important note: This communication has been prepared to provide general information and does not constitute ‘financial advice’ for the purposes of the Financial Advisors Act 2008 (Act). An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this communication, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, ‘AMP’) make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.