Infrastructure: Greater than the sum of its parts

Over recent years, Global Listed Infrastructure (GLI) as an asset class has continued to gain prominence.

25 Jun 2019

In Zenith’s 2019 Infrastructure Sector report, we noted that GLI continues to show attractive benefits within diversified portfolios. These benefits include equity-like returns with lower volatility, greater downside protection and attractive, stable yields.

Zenith believes it is difficult to assess the efficacy of GLI without appreciating its sub-sectors, each of which contain unique return profiles. Zenith believes it is these unique properties that means GLI is greater than the sum of its parts. The combination of these return profiles drives the attributes of the sector and continue to reinforce Zenith’s view that GLI is a legitimate standalone asset class and not merely a sub-set of general equities.

Definition the key to infrastructure

GLI companies are defined according to the assets they own, with typical features including:

• High barriers to entry
• Providing essential services
• Regulated or concession-based revenue models
• Stable earnings
• Long-life assets 

Within GLI, sub-sectors are subject to differing levels of regulation, market competition, elasticity of demand and length of asset life. It is the combination of these factors which influences their stability and growth of earnings, which in turn influences the return profile.

In practice, the infrastructure characteristics vary across and within the sub-sectors. In the chart below, Zenith highlights the unique return profiles of the sub-sectors by charting their volatility and equity beta relative to the MSCI World ex-Australia (Hedged) $A Index over the last five years.

A beta of 1 indicates a sub-sector’s performance is largely explained by the performance of global equities. Conversely, a low beta indicates that performance is not explained by global equities, with returns driven by specific stock factors.

Regulation and beta

The difference in beta between utilities and the other sub-sectors highlights the importance of regulation, market competition, demand elasticity and length of asset life in shaping returns. Zenith attributes utilities’ low equity beta to these companies typically operating under a Regulatory Asset Base (RAB) model whereby asset owners receive a regulated return on their investment which is sufficient to service capital expenditure, service debt and to generate profits.

Under the RAB model, regulated utilities assets have low exposure to user demand and little competitive pressures. This means these assets typically have the most certain earnings steams in the GLI sector. As such these assets show lower levels of sensitivity to general equity movements (measured by equity beta) and are more likely to be influenced by stock specific factors.
At the other end of the beta scale is the pipelines and railway sub-sectors. These networked assets are of strategic importance with strong monopolistic characteristics. However, their earnings streams are less certain as they are governed by concessions or contracts that expose the assets to greater competitive forces, when compared with a RAB model. As such their market risk (measured by beta) is higher.

Other sensitivities

Another point of consideration is how various sub-sectors are influenced by other macro factors such as commodity prices or interest rate movements. As shown below, Zenith has sought to highlight each sub-sectors’ sensitivity to equity market movements (measured in beta) as well as its correlation with commodity markets and a qualitative measure of sensitivity to interest rates.

GLI continues to play its role

Zenith believes that over the three years ending 31 March 2019, the Zenith hedged peer group of funds has provided both lower volatility and lower equity beta when compared with global equities. Building on our analysis of the sub-sectors, the below chart outlines the Zenith hedged peer group, showing their relative equity beta and volatility over the same period.

Downside protection and defensiveness

As shown in the chart above, on an absolute basis, the Zenith hedged peer group has delivered upon the defensive qualities of lower volatility and equity beta. Relative to the Zenith assigned infrastructure benchmark however, most funds displayed a higher level of volatility over the period which Zenith attributes in part to the higher concentrated approach taken by most managers.

Zenith believes GLI has continued to show evidence of its ability to provide some protection when general equities experience sharp drawdowns. At the end of 2018, global stocks suffered their worst quarterly fall since September 1998, with the MSCI World ex Aust $A (Hedged) suffered a fall of -13.60% for the quarter, driven by persistent worries over trade and economic growth.

During this period however, GLI funds continued to show evidence of their ability to provide a level of protection while general equities experience sharp drawdowns. Over the December 2018 quarter, Zenith’s rated GLI funds returned an average of -2.26%.

Zenith believes that this reinforces the message that whilst GLI invests in listed assets, the asset class offers investors greater drawdown protection owing to the stable income, high barriers to entry and monopolistic positioning of underlying companies.

Overall, Zenith believes that the case for GLI remains strong, with the asset class delivering attractive returns over the 12 months to 30 April 2019 and over the longer term when compared with global equities.

By Dugald Higgins, Head of Property & Listed Strategies.