Infrastructure assets can add diversification and potential returns to multi-asset portfolios in the current volatile, low-yield environment. Here, James Lydotes, managing director of The Boston Company Asset Management, LLC, explores the current trends driving change in the sector.
Even while global economic growth remains muted, population growth and the demand for the basic needs of civilization such as reliable supplies of water, energy, health care and transportation continue to increase. The United Nations population division forecasts global population will rise from 7.3 billion in 2015 to 9.7 billion in 2050.1
While the increase in population helps fuel the growth of demand for public services and their accompanying infrastructure, the changing characteristics of that population are also creating demand for new varieties of infrastructure to be built and operated. While the addition of 2.4 billion people over 35 years is not insignificant, the rate of increase represents a slowing of population growth in much of the world.
The inevitable result of slower population growth is an overall rise in the age of the population, a phenomenon that’s already taking place in much of the developed world. According to the United Nations, the number of people aged 60 and above will more than double by 2050, while the number over 80 will more than triple.
While the needs of this older and more numerous population increase, the ability of the governments that led the construction of infrastructure during the 20th century to do so in the 21st is diminishing. Public budgets in developed markets are constrained by high levels of debt, while emerging markets struggle with slowing growth. Standard & Poor’s has estimated that the annual gap between worldwide infrastructure investment needs and available public funds will be at least $500 billion in each of the next 15 years.2
In developed markets, the need for infrastructure investment results partly from the aging of both people and systems. Many public water and sewage systems date from the 19th century and their condition, as notable events in Flint, Michigan3 and elsewhere have shown, cannot be taken for granted. The network of roads and bridges that was built to accommodate the 20th century automobile boom also continues to age and deteriorate. Meanwhile, the existing fossil fuel-based energy production and delivery infrastructure is increasingly ill-suited to a world where limiting carbon emissions is an increasing priority.
The aging of their populations is also creating demand for infrastructure and service provision in developed countries. As people age, their utilization of health care increases significantly and governments in many countries lack the funds to build new hospitals.
Emerging markets have younger populations and stronger growth potential, but their already-insufficient infrastructure faces acute pressure from rapid urbanization. Countries such as India need massive upgrades to their transport, water and power systems. Tremendous demand for this kind of primary infrastructure exists in emerging markets and governments must find ways to build these projects if they expect to achieve their growth potential. The Asian Development Bank has warned that EM economic growth forecasts will not be achievable if an $8 trillion infrastructure funding gap for the period 2010-2020 is not closed.4
Both emerging and developed markets are also grappling with how best to build communications infrastructure to keep pace with the rapid evolution of technology and consumer behavior. New generations of smartphones, the proliferation of tablets and other mobile devices, and the “Internet of things” are rapidly making existing telecom networks obsolete. The mobile tower networks operated by specialist infrastructure operators must continue to evolve to meet the demand for data as more of the world’s population conducts more of their economic and social lives using personal electronic telecommunications technologies.
In developed and emerging markets alike, the gap between the needs of populations and governments’ abilities to build and maintain the systems that service those needs is creating opportunities for the private sector to partner with governments to provide necessary infrastructure. Particular opportunities exist where governments have mandated the provision of a service, but have difficulty funding it.
Renewable energy mandates are an example of this. In Europe and North America, climate change and energy security concerns have already spurred major policy initiatives to invest in renewables. Projects such as the North Sea Offshore Grid in Europe, which aims to generate 40 gigawatts of wind power by 2020, and the U.S. Clean Power Plan 2015, mandate a shift to wind and solar investment and require new investment in power transmission systems. By requiring specific targets for renewable energy production, governments create natural opportunities for public-private partnerships or public-private agreements where the government mandates the need for a service, and the private sector steps in to meet the need.
While infrastructure investment may not be uncorrelated to the other varieties of equity investments contained in multi-asset portfolios, it does possess unique characteristics that may benefit investors by reducing the volatility of their portfolios. Infrastructure investments’ return streams are backed by real assets that require significant capital expenditure up front to build facilities but relatively little capital to operate and maintain over lifespans that may be measured in decades if not centuries. Over their lifecycles, these businesses generate cash, and return a significant amount of it back to shareholders in the form of reliable dividend payments which are relatively insulated from economic cycles. Many infrastructure investments also have relatively high barriers to entry, which discourage disruptive competitors. These characteristics present attractive opportunities under many market conditions, but especially so in a low-interest-rate environment where other opportunities for these sorts of reliable returns are limited.
Of course, where there is investment, there is also risk. Construction and operation challenges and changes to government policy can all delay and diminish investment returns. Infrastructure projects undertaken purely for profit-seeking motives, such as the Northeast Energy Direct natural gas pipeline project in the northeastern U.S., can encounter public opposition and changing business conditions that can raise potentially significant risks to their ability to generate expected returns. For investors, though, investment in companies engaged in the development, management, and ownership of assets related to energy, communications, water, transportation, and other essential systems may deliver consistent cash flow, inflation protection and diversification while also helping to moderate multi-asset portfolio volatility.
A Different Path: Global Listed Infrastructure
While many investors recognize the benefits of infrastructure investment within a multi-asset portfolio, direct investment in infrastructure projects presents risks that may deter even large institutional investors. Direct investment requires specialized expertise and the size and scale of projects may work against the goal of diversifying a multi-asset portfolio. However, it is also possible to invest in public infrastructure companies listed on global exchanges as another means of gaining exposure to infrastructure.
Global listed infrastructure is a broad and diversified universe of public companies that develop, manage, and own assets related to energy, communications, water, transportation, and other essential systems. Real asset investment manager CenterSquare believes that in the coming years, listed companies will grow to play a much larger part in the infrastructure market, outweighing the role of governments, institutional investors, and private institutions. These companies have the experience to develop and operate infrastructure assets efficiently and profitably, as well as the capital to invest in multiple assets and projects, and the transparency and good governance necessary to secure the trust of the capital markets and obtain attractive financing.
Listed infrastructure company stocks’ risk and return characteristics are determined by the quality of their underlying assets. Key factors that determine quality include strong cash flow visibility, low commodity risk, long duration contracts and steady long-term demand outlooks.
CenterSquare believes global listed infrastructure is poised for tremendous growth and presents attractive risk and return characteristics with lower volatility. In today’s economy, plagued by elusive growth and historically low yields, it is a liquid alternative investment with the potential to generate both yield and growth.