Deputy chief investment officer of equities, head of the global equity income team and portfolio manager at Newton Investment Management, part of BNY Mellon Investment Management – in Boston. Joined Newton in 2021.
The cost of a soft drink in 2018 was nearly the same as it was in 2017, and likewise nearly the same as it was in 2016. Prior to 2021, investors had benefitted from a nearly three-decade run of low and stable inflation. In developed markets, particularly the United States and western Europe, prices for goods and services were generally steady overall year after year. Today, however, that paradigm has shifted, and investors are grappling with a new normal of soaring inflation and market volatility. As inflation continues to surge and uncertainty lingers, we believe that investors should consider looking to global infrastructure securities for their potential to provide not only downside protection in this current risk-off environment, but also a reliable hedge against inflation. Regardless of the method used to value a business, we believe the conclusion is the same—the unique features of listed infrastructure companies, which provide essential services for our society, can hold up as a buffer in this inflationary environment.
A shifting paradigm
Currently, the investment community is keeping a watchful eye on the pace of inflation, and for good reason. After 30 years of importing deflation from around the world, one of the most significant imports over the last year for most countries has been inflation. Supply-chain issues, higher commodity prices—further pressured by the conflict in Ukraine—and increasingly hawkish central-bank policy have all served to push inflation into double digits in many developed parts of the world. Emerging markets, which have historically managed with more normal and consistent levels of inflation, are also witnessing these measures surge. This global cost of living increase has created a sense that a recession may be inevitable.
Given the backdrop, where do you go?
In this challenging market backdrop, investment managers need to determine how to best allocate their assets to deliver income for their clients while also protecting against inflationary headwinds. We believe that global infrastructure investments have the characteristics needed to provide just that. Listed infrastructure securities are issued by companies with hard-asset-owning business models in heavily regulated industries. These are typically dividend-paying equities, and as such they generate stable cash flows that are distributed to shareholders in the form of dividends.
Determining the value of a business?
Inflationary pressures can create uncertainty for investors, especially in seeking to value their investments. To determine the valuation of an asset or a business, investors essentially use one of two fundamental approaches: the cash-flow method and the asset-based method. With the cash-flow method, a business is evaluated based on the present value of its future cash flows. With the asset-based method, a business is evaluated based on the company’s liabilities versus its assets. We believe that both methods can favor hard-asset-owning regulated businesses.
When valuing a business on the present value of future cash flows, preferred businesses are able to pass through inflationary pressures, as cash flows adjust in step with inflation. Infrastructure assets are generally regulated, and the revenue is governed by long-term contracts with these built-in inflation pass-through mechanisms. As with most businesses, it is necessary to consider their ability to withstand inflationary pressures, and with infrastructure assets this feature is effectively ensured by these contracts and structures.
From an asset-based valuation perspective, rent collecting, asset-owning business models, such as pipelines, nursing homes and airports, will all generally see the value of their assets appreciate with inflation, as their rents will typically keep pace with pricing pressures. Assets appreciate while liabilities remain the same, and companies are left with a net asset value (assets minus liabilities) that should keep pace with these pressures.
Against this challenging market backdrop, we believe investors need to determine how to best allocate assets to deliver income while also protecting against inflationary headwinds. We believe that global infrastructure investments have the characteristics needed to do just that. Listed infrastructure securities are issued by companies with hard-asset-owning business models in heavily regulated industries, with contracts allowing for a pass-through of inflationary pressures. These are typically dividend-paying equities, and as such can generate stable cash flows that similarly keep pace with inflation. Regardless of the valuation method, we believe infrastructure assets stand out as a beacon in the inflationary storm.
All investments involve risk, including the possible loss of principal.<.strong> Certain investments have specific or unique risks that should be considered along with the objectives, fees, and expenses before investing.
No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment.
Equities are subject to market, market sector, market liquidity, issuer, and investment style risks to varying degrees. Investing in foreign denominated and/or domiciled securities involves special risks, including changes in currency exchange rates, political, economic, and social instability, limited company information, differing auditing and legal standards, and less market liquidity. These risks generally are greater with emerging market countries.
There is no guarantee that dividend-paying companies will continue to pay, or increase, their dividend. High-dividend stocks may not experience the same capital appreciation as non-dividend paying stocks during periods of high growth for equities.
Recent market risks include pandemic risks related to COVID-19. The effects of COVID-19 have contributed to increased volatility in global markets and will likely affect certain countries, companies, industries and market sectors more dramatically than others.
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