348. Unlocking the power of infrastructure

27 February 2025 (pre-recorded 20 February 2025)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. Infrastructure plays a vital role in our daily lives, from the roads we travel to the digital networks we rely on. But, this week, we consider what makes it a compelling investment opportunity?

James Yardley (JY): I’m James Yardley and today I’m joined by Alex Araujo, the fund manager of the M&G Global Listed Infrastructure fund. Alex, thank you so much for joining us today.

Alex Araujo (AA): Thank you, James. Thanks for having me.

[INTERVIEW]

JY: So Alex, I guess the first main question is, why should investors consider an allocation to infrastructure for their portfolios? Particularly now, I guess that, you know, we have seen a normalisation in interest rates and you can get some decent returns from fixed income. Now, why should investors stick with or consider infrastructure?

AA: Well, I’d say the fundamental reason for having exposure to the asset class is what the underlying exposures themselves are. We can talk about timing separately to your point on interest rates, but fundamentally, an investor exposed to an infrastructure strategy such as this one is taking on the same types of exposures to assets that they use every day.

So if we think about your everyday life, when you wake up in the morning and you start making use of your utility services, for example, your water supply, your gas supply, your electricity supply, your calling on infrastructure assets and their critical nature for the smooth functioning of economies and societies. We have a number of exposures in the more economic infrastructure realm, including utilities which also encompass energy security and the energy transition, which is obviously a very important large scale structural theme.

We have energy infrastructure that is oriented towards the movement of products, the storage of products including gas. And we have transportation infrastructure exposures, which covers everything from toll roads and airports to public transit networks. So as you can see, as you’re moving through your day, you’re starting to make use of all of these infrastructure assets. And our reliance upon these types of assets is reflected in the consistency and reliability of the cashflow streams that they generate.

We extend the definition of infrastructure in our own strategy to social infrastructure, which would include things like hospitals and schools and so on. And we have a more modern interpretation of infrastructure in one of the segments that covers things like digital infrastructure, which would include data centres, which of course are critical to the development of artificial intelligence capabilities. And all of these things wrapped together in a global strategy gives a highly diversified set of exposures to assets that are critical and long life in nature.

And I will point out that there is underlying inflation protection in the way we manage the assets in this fund because we have an objective to grow the income stream to investors consistently over time at a rate higher than the actual inflation rate, which is something that we’ve been able to do recently.

JY: And therefore, do you think your fund is primarily for income investors or do you think it’s also potentially for growth investors as well?

AA: Yeah, we offer a combination of income and growth. The income yield, the dividend yield is generous relative to the broader equity market. It sits today at a little over 4%, but it’s not through the roof. It’s actually quite easy to find high yielding infrastructure assets out there. But we focus on the ones that have structural long-term growth prospects that centre around new and better infrastructure investments, the energy transition and energy security, as I mentioned, structural growth in emerging markets, social and demographic needs, for example. And then of course, the digital infrastructure side, which is growing very quickly. So it is a combination.

I would say that we have a quality bias because we’re fixed asset investors, obviously only investing in listed instruments, but those companies themselves have fixed assets, fixed physical assets at their core, which bring them some form of strategic advantage, barrier to entry, oftentimes related to a physical barrier to entry.

So you think of, let’s say Heathrow Airport in this country which has the prospect of expanding, there’s a growth opportunity there. Whether it happens or doesn’t happen, it’s still a critical asset and nobody’s going to build an airport anywhere close to Heathrow to compete with the traffic that comes in and out of one of the busiest airports in the world. So this is the kind of positioning that we look for in the companies and their underlying assets.

And where that growth ultimately gets expressed is by way of the dividend growth objective, which then translates to an income growth objective for our investors. And that dividend growth needs to be driven by cashflow growth, earnings growth that is progressive and sustainable.

JY: And so you’ve got the three different buckets in the fund. You’ve got your economic infrastructure, your social infrastructure, and then your evolving infrastructure. So as you say, it’s very well diversified. Do you want to go into a little bit more detail, say on things like the social infrastructure, what are you investing in there?

AA: Yeah. Social infrastructure are fixed assets that are critical for the functioning of society. I already mentioned hospitals, for example. They feature in there schools, universities, municipal, civic buildings. These kinds of assets that I think we oftentimes take for granted and quite often are actually provided for governments either federal or local, let’s say national or local, and where the contractual arrangements are very secure and oftentimes inflation protected.

We also even have companies in that category such as one that provides life sciences infrastructure, in other words very specialised facilities that are used for the testing and the development of pharmaceutical drugs, for example. So it’s a unique positioning, tends to be a bit more interest sensitive. So we have been seeing a lot of opportunity there in terms of valuations. So that’s what the social infrastructure component would, would more or less look like.

JY: And then you mentioned the digital infrastructure and the data centres. I mean, that’s basically been quite topical recently. There’s been a lot of discussion about the huge build out of data centres. [AA: Indeed.] So presumably that’s a growth opportunity. Are you a believer in the AI story then?

AA: Yeah. We in a sense sell the picks and shovels to the industry. So in other words providing space in the data centres and the opportunity for all of those AI chips to go into servers and go into those facilities. They do need a physical presence. And those facilities are highly specialised as well. They require power, they require cooling, they require connections to things like subsea cables and carrier networks. And you even have connections with within the data centre between the actual tenants. So they’re highly, highly strategically positioned. And of course, as you point out, growing very quickly as the demand for space continues to grow. And it’s not just AI, of course, it’s cloud-based services and anything to do with data processing and telecommunications and this increasingly digital virtual world that we inhabit.

JY: And how much does geopolitics impact you and the fund? I mean, obviously there’s been a lot of tension recently, the ongoing war with Russia and Ukraine, and obviously Trump coming in and changing a lot of relationships. So does that really have much of an impact for your fund, or, I mean, whereabouts do you invest in the world? Is it, predominantly, presumably, it’s in developed markets like it’s US and Europe.

AA: Yes. You highlighted an important geopolitical theme that being the conflict in Eastern Europe, when that all kicked off, the importance and need for secure energy supply, particularly to Germany, for example, became very prominent. And the build out of grid networks local low voltage networks liquifaction and/or regasification facilities for liquified natural gas all of these physical infrastructure assets needed investment. And at the heart of the solution of ensuring energy supply were physical assets, even including gas pipelines, for example to provide alternative sources or means of transporting that those products.

Separate from that, there can be some currency related fluctuations related to geopolitics. Sometimes politics interferes in regulatory regimes, which we have to keep an eye on. And even interest rates can move on the back of geopolitical type developments. And luckily, we invest only in liquid listed securities. So we do have the flexibility to move around and invest where we see opportunity. So that would typically be how geopolitics would affect the fund in the extreme.

You’ll sometimes, particularly in frontier markets, developing markets have state interference in the actual companies and assets. So forced corporate transactions and those kinds of developments. But for that reason, as you say, we mainly stick to developed markets where we feel our capital is ultimately safe.

JY: I noticed you’ve got a bit of gold exposure in the fund, which is potentially quite unusual for an infrastructure fund. What your thinking there? I mean, is it exposure to miners and things like that?

AA: No, not miners at all. It’s indirect exposure, and it comes by way of a segment of the portfolio that we call royalties. Royalties are companies whose physical asset base is actually related to land holdings. So huge land holdings on which they are entitled to a perpetual royalty on anything produced by a third party from those lands.

So these companies don’t actually have their own operations or mines, but they have the perpetual royalties on the physical land holdings. And in one case, one of our holdings has huge portfolio land positions related to gold mining, copper mining. And for that reason, there is an indirect exposure to the gold price, which has been very, very convenient of late as many people are aware in part related to geopolitics, but also inflation and other considerations. And so that’s been a unique and quite beneficial set of exposures.

And we also have a similar type royalty business related to energy products. So there’s no operating risk, there’s no environmental risk around these kinds of of exposures, but they certainly provide some diversifying elements for the strategy.

JY: And what is your general outlook for the global infrastructure sector now? As I mentioned before, we have had this normalisation and interest rates. [AA: Yeah.] So presumably that means the expected forward return of this fund should hopefully be higher than it was in the past. Is that fair?

AA: Yeah, I would certainly think so. If we look at the asset related opportunity, I think many of us will only have to look around us to realise the investment requirements in infrastructure and the opportunity that exists, particularly in development markets as it as it happens. If we think about the world’s richest economy and country we have infrastructure assets, particularly in transportation that are in a parlous state. And that also would encompass, say electricity grids and water. So the opportunity to invest and earn returns is enormous around the world, across the various categories that we’ve talked about and the timing to do so.

In my mind, to your point is opportune interest rate movements have disproportionately, and I would argue unfairly punished valuations in this asset class. But companies themselves continue to do very well and grow their income and grow their dividends. Yet the market is, as we all know, obsessed with certain pockets of the equity market and leaving behind, ignoring and indeed punishing some of the less, I suppose, less exciting, in some eyes. I find it very exciting, but perhaps even considered defensive types of of exposure such as the ones we have in the fund.

So the asset class itself has underperformed the global equity market for more than two years. Part of that is interest rates. I thought, in fact, I’d say most of it is interest rates. And I don’t want to suggest that the interest rate environment is actually punitive to the companies themselves. They actually are doing relatively well in the circumstances. It’s more of a market sentiment and relative valuation story that I see having unfolded in the last couple of years. And that’s been a record as far as we can tell for how long the asset class has underperformed the broader equity market.

Up until a couple of years ago, in fact, on the five year anniversary of the strategy the total return performance was actually in excess of the broader equity market, which we were very proud of. So we’ve had  a deep reversal, and I would have to think that ultimately we will have a normalisation. I do believe that a return to less concern around interest rates will help as will a general rotation within the equity market back towards sectors such as the ones that are mainly represented in the fund.

JY: Brilliant. Well, thank you very much for sharing those thoughts, Alex. That’s been really interesting and a very interesting fund and area of the market. So thanks for joining us today.

AA: It’s a great pleasure, James. Thank you very much.

SW: This is an infrastructure fund that invests in more than just the traditional areas. The modern infrastructure investments – such as payment companies and data centres – differentiate this fund against its peers. To learn more about the M&G Global Listed Infrastructure fund visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts.