Zenith Infrastructure Sector Review 2017
Global listed infrastructure continues to gain traction in client portfolios, as well as enjoying strong returns in investment markets. The aggregate funds under management (FUM) within Zenith’s rated funds increased from $A32.5 billion to $A41.8 billion over the 12 months to 30 April 2017, a growth of 28.6%.
At the same time, global listed infrastructure as represented by the FTSE Global Core Infrastructure 50/50 $A (Hedged) Composite Index generated a return of 14.2% for the 12 months ended 30 April 2017.
Justin Tay, Senior Investment Analyst, explains the drivers of this growth: “Zenith believes this growth is due to the widely accepted defensive characteristics of infrastructure assets, which continue to appeal to clients.”
“Specifically, we believe clients are attracted to infrastructure’s steadier earnings sources and stability of returns.”
From an investment performance perspective, global infrastructure securities, like broader risk assets globally, have benefited from the low interest rate environment that commenced around the Global Financial Crisis (GFC) in late 2008 to early 2009. The reduction in interest rates has had a direct impact with regards to the valuation techniques used for infrastructure assets.
“Taking the prospect of tightening monetary policy into account, Zenith believes the tailwind that infrastructure securities enjoyed could soon become a headwind,” said Tay.
“On the upside, global listed infrastructure is comprised of multiple sub-sectors, each which has different return drivers, characteristics and ultimately, different sensitivity to interest rates.”
Generally, those sub-sectors that have higher yields, higher leverage and are less exposed to the broader economy, such as Towers and Utilities, are more sensitive to interest rate movements. Conversely, subsectors that have lower yields, lower relative leverage and are more exposed to the broader economy, such as Railways and Ports, are less interest rate sensitive.
“Considering the different sensitivities to interest rates across infrastructure sub-sectors, we believe it is too simplistic to apply a broad-based assumption that all infrastructure investments are bond proxies,” said Tay.
The impact of inflation
For long duration assets such as infrastructure, Zenith believes inflation should also be a major consideration because it can potentially erode the value of future cashflows that are many years out. Inflation in most developed markets has been benign since the GFC as the global economy experienced its recovery period, however pro-growth policies such as those espoused by President Trump, are likely to cause inflationary pressures.
“Global inflation rates post GFC are near historical lows,” said Tay.
“Infrastructure is typically understood to possess inflation hedging characteristics, however this is not across the board in terms of the various infrastructure sub-sectors.”
For example, toll roads typically have explicit linkages to inflation as per their concession contracts; on the other hand, an oil pipeline may not have an explicit ability to pass through inflation to the end customer given that their returns are determined by the market, but may have limited linkage from rising commodity prices feeding through to inflation. Furthermore, even in a sub-sector with traditionally low linkage to inflation, a specific asset typically monopolistic in nature may deliver inflation protection through pricing power alone.
“While Zenith believes global listed infrastructure can provide some inflation protection, investors need to be cognisant that it is not a perfect hedge due to the variability of inflation protection across the sub-sectors within the asset class,” commented Tay.
The importance of active management
Given the potential challenges ahead for global infrastructure securities, Zenith believes that active management can add significant value to client portfolios.
“Through the development of well-informed views and the flexibility to deviate from traditional global listed infrastructure benchmarks, active managers can position portfolios to enhance or maintain the defensive characteristics of infrastructure strategies,” said Tay.
“Although infrastructure assets may share similar attributes, clients need to pay close attention to how assets within the sector are defined and classified – we do not believe all infrastructure exposures are equal with regards to the ability to exhibit a defensive risk/return profile when needed.”
“Going forward, given the potential for heightened macroeconomic impacts, Zenith believes that it is imperative that investors consider the case for active management within global listed infrastructure,” Tay concluded.
Summary of the Zenith 2017 Infrastructure Sector Review:
From an initial universe of 22 products:
- 4 were rated “Highly Recommended”
- 10 were rated “Recommended”
- 3 were rated “Approved”
- 5 were “Not Rated”
Full details can be found in the Zenith 2017 Infrastructure Sector Report.