For financial professionals only
This is the second in a series of 5 articles exploring our new Diversified Alternatives asset class. Here, Meera Hearnden discusses the many merits of infrastructure.
Imagine diversified portfolio assets such as equities, bonds or property as cogs in a machine. Infrastructure is an additional cog that can help that machine work efficiently and provide greater balance. We’ve recently introduced infrastructure into our portfolios in recognition of several enhancing benefits.
What is infrastructure and why’s it important?
Infrastructure assets are essentially the building blocks that allow an economy to function successfully. They provide vital services and facilities such as hospitals, schools, housing, transportation – right through to power networks and renewable energy. Without these we couldn’t power our homes, transport goods or travel, so having good infrastructure links is essential.
Infrastructure matters because these assets are long-term and provide opportunities to invest in the future of society. Over time, the assets need maintenance, upgrades, or more capacity. This requires a significant amount of spending, as seen in the chart below:
Infrastructure investments are generally supported by governments or benefit from a regulatory framework to provide predictable income streams to investors. This means cashflows are supported by the long-term demand for assets and don’t depend on the economic cycle, making them fairly attractive from a total return perspective.
What are the portfolio benefits?
We hold infrastructure within Diversified Alternatives, which also includes other non-traditional assets such as Property, Absolute Return and Short Dated Corporate Bonds. Compared to these, infrastructure has low correlation benefits as its focus is on real assets, so it acts as a true diversifier. Infrastructure investments can also provide better consistency of cashflows, underpinned by the underlying assets, so can pay out attractive levels of income.
Infrastructure assets are normally accessible through liquid instruments such as investment trusts and equities. Their volatility may look high, but the volatility profile of the underlying asset is much lower – so there are, arguably, lower volatility benefits compared to global equities. The return profile can be differentiated from traditional assets, and has the potential to provide defensive characteristics in a wider portfolio during times of uncertainty.
What are the risks?
As with any investment, infrastructure investing is not immune to shocks like the Covid pandemic. As countries worldwide imposed national lockdowns, key transport links were effectively shut down. It was something the sector had not experienced before and highlighted a potential risk to revenues and dividends.
Fortunately, the recovery was quick and the resilience of the underlying assets’ income generation was clear. As many infrastructure project revenues come from long-term contracts, often supported by governments, this made the income generation more stable than global equity dividends – going some way to offset the market falls.
Inflation could be considered another risk as it can lead to interest rate rises. Infrastructure can be sensitive to interest rate changes, but this depends on whether it’s driven by higher inflation or real economic growth. When rising interest rates are in response to real economic growth, infrastructure assets tend to lag as investors shift from defensive to growth assets. If rate rises are due to inflation, as we’re currently seeing, infrastructure companies have the ability to pass on higher costs to consumers, as the assets have an explicit link to inflation.
The power of diversification
Although all investing comes with a degree of risk and volatility, the benefits of infrastructure investing are clear. The asset has plenty to offer in terms of stability of income, low volatility and lower correlation to equities. When combined with other assets, the benefits of diversification are really evident in our long-term modelling. Portfolios that are diversified across a number of assets can achieve better consistency of risk adjusted returns over the longer-term.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.