Charting the path forward for infrastructure investments

Joss Murphy 15/05/2024 in Equities, Specialist investing

Infrastructure investment has historically provided good ballast to a portfolio. Operating in critical parts of the economy, it is less sensitive to the highs and lows of economic growth. While performance may not be exciting, it should be defensive, providing stable, all-weather returns. Only, it hasn’t quite worked out like that. The sector has been hit by a series of problems, which left it as one of 2023’s major laggards, and still trailing in 2024.

A significant part of the problem has been interest rates. During the low interest rate years of 2008 to 2022, investors turned to infrastructure assets as a source of reliable, inflation-adjusted income. It fulfilled a role in portfolios previously taken by fixed income. The problem has been that, as interest rates have risen and investors have been able to get higher yields on cash and fixed income, they have turned back to those areas and away from infrastructure.

Outflows have been significant, and have continued even though interest rates have stabilised. The sector saw outflows of £68.6m in March*, and £83.2m in February**. Central banks continue to push out interest rate expectations, which is keeping bond yields higher. Even though infrastructure companies are doing what they have always done, generating reliable cash flows from critical assets, selling pressure has pushed prices lower.

There have also been significant problems in parts of the investment trust sector, which is how many investors access infrastructure investments. Various regulatory changes have weakened demand from wealth managers for investment trusts. They had previously been significant buyers of infrastructure funds, particularly in the renewable energy sector. As they withdrew from the market, discounts widened significantly on infrastructure trusts and performance has been weak.

The better news

While the short-term trajectory for infrastructure assets has been difficult, there are still plenty of long-term drivers for the sector. The Global Infrastructure Investor Association (GIIA) says: “The 4D megatrends of decarbonisation, digitalisation, demographics, and deglobalisation have become commonplace trends in infrastructure, that remain significant drivers of investment. Private infrastructure investors are well positioned to fill the gap between infrastructure targets set by governments globally and the challenging fiscal and monetary environment facing public sector finances.”

Those government targets can be significant – in India, for example, the government unveiled plans to spend $134bn on infrastructure development. There have been vast infrastructure development plans put in place by governments around the world as they try to ensure they are ahead in areas such as the energy transition. The US Bipartisan Infrastructure Deal, for example, allocated $90bn to upgrade the country’s transport system, $25bn for its airports, and $17 billion for port infrastructure and waterways.

A report from McKinsey Global Institute found that the world needs to invest about 3.8% of GDP from 2016 to 2030, or an average of $3.3 trillion a year, in economic infrastructure just to support expected rates of growth***.

Equally, over the longer-term, the infrastructure sector continues to grow and diversify. There are new types of mission-critical infrastructure emerging all the time, which enhance the opportunity set for investment managers. For example, artificial intelligence requires vast data resources to generate its insights and power its growth. Fibre networks and data centres are now becoming critical infrastructure to enable companies and countries to remain competitive. The Schroder Digital Infrastructure fund, for example, seeks to take advantage of the ever-increasing demand for digital infrastructure and the sustainable transition to a digital economy.

Read more: Five-minute guide to digital infrastructure 

The energy transition continues to change the infrastructure landscape, with new opportunities in renewables, biogas, hydrogen, or energy storage. Transportation is changing. Currently the second largest source of greenhouse gas emissions in Europe****, it is a major target for policymakers. Investment opportunities are emerging from grid expansion, and the electrification of public transport networks. At the same time, industralisation in emerging markets is bringing new growth opportunities. Looking forward, this is a strong backdrop for the sector.

Ways to access infrastructure investments

The right route for infrastructure investment will vary with each investor. The two main options are via bricks-and-mortar infrastructure investment, or via listed equities. The giant bricks and mortar infrastructure funds will own and operate stand-alone infrastructure assets, such as toll roads, mobile towers, wind farms or hospitals. They will operate these assets under contracts agreed with the government, which generate long-term, inflation-linked cash flows. The assets are very illiquid, so companies investing in them are usually structured as investment trusts. The behemoths of the sector include HICL, International Public Partnerships, and GCP Infrastructure.

Funds such as M&G Global Listed Infrastructure and First Sentier Global Listed Infrastructure will invest in listed infrastructure assets. The First Sentier fund, for example, aims to invest across a balanced portfolio of infrastructure sectors, including energy, transportation and digital. Its top holdings include renewable energy group NextEra Energy, mobile tower operator American Tower Corporation and US railroad group Union Pacific^. These are more often structured as open-ended funds and have proved less volatile than the infrastructure investment trusts.

It is a feature of both types of fund to pay an attractive dividend. In spite of its recent wobbles, income from infrastructure assets has been stable and infrastructure remains a good option to diversify income generation in a portfolio. Infrastructure assets usually have inflation-adjusted rises built in (in a way that fixed income and cash do not) which means investors can be reassured that their income will grow in line with price rises.

There is plenty to suggest that infrastructure may be through its fallow patch, and about to resume its normal place in a portfolio as a source of predictable income and steady capital growth. Interest rates have stabilised and valuations have normalised.

GIIA says: “As interest rates moderate, bond yields stabilise, and central banks pivot towards rate cuts, the outlook for 2024 anticipates a gradual recovery, buoyed significantly by global megatrends such as decarbonisation and digitisation. Moreover, a mounting public deficit positions private infrastructure investment at the forefront of efforts to fulfil governments’ net-zero ambitions.”

Infrastructure has been through an unusual period, which has disrupted its long-term trajectory. However, the market has stabilised and it should resume its normal place as a reliable, if unexciting, ballast in investor portfolio, a source of diversifying income and steady growth.

Research all Elite Rated infrastructure funds

*Source: Investment Association, March 2024

**Source: Investment Association, February 2024

***Source: Bridging Global Infrastructure Gaps, June 2016

****Source: abrdn, 13 December 2023

^Source: fund factsheet, 31 March 2024

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