Building infrastructure investments into portfolios

As the backbone of the global economy, infrastructure provides essential services to the world’s population and is crucial for sustained economic and social activity.

So what makes harbours, railroads, bridges and water pipelines attractive for an investor? Firstly, revenue from infrastructure assets is typically linked to inflation, helping investors to earn a real income return on their investment. Secondly, infrastructure assets are often supported by regulation, reducing competition and underpinning real revenue growth. In certain instances, revenue increases linked to inflation are embedded in concession agreements, licences and regulatory frameworks. In other cases, owners of infrastructure assets are able to pass inflationary pressures on to consumers via price increases, due to the irreplaceable nature of the assets and their inelastic demand.

Concession holders (and their investors) can realise significant economies of scale because high barriers to entry, which are further protected by regulation, discourage competition, such as with toll roads or airports. This results in an advantageous monopoly for existing owners and operators.

A well structured infrastructure strategy should offer a diversified portfolio of global infrastructure securities with stable underlying assets and strong cash flows, owned and managed by competent management teams with appropriate capital structures. In addition, the attractiveness of the pure play infrastructure approach is due to the attributes typically sought by infrastructure investors: an inflation-linked, stable long-term cash flow profile and a favourable dividend yield that grows over time in line with overall economic activity. These assets display low correlation to other classes, providing excellent diversification.

A critical component within this process is manager selection, which is approached according to three key pillars – qualitative, quantitative and operational due diligence.

The qualitative aspects of this process are by far the most noteworthy area of focus. By rigorously evaluating a manager’s investment process, selectors seek to identify investment managers whose performance track records are repeatable. Based on our understanding of these managers’ investment philosophies and processes we seek to accurately anticipate future performance under varying market conditions in order to understand in which market cycles to allocate capital to a particular manager.

A thorough quantitative due diligence process should support and augment qualitative research. Here we try to understand the risk implicit in a manager’s portfolio using mathematical and statistical analysis to see how much risk they took on in generating historical returns, how they compare to their peers and their internal benchmarks. Quants can also be used extensively in the portfolio construction process in order to combine managers into portfolios in an optimal way.

Lastly, an internal operational due diligence team with full veto powers should perform operational due diligence on any investment the investment team recommends. The aim of this analysis is to prevent investment into any fund or investment manger that does not have sound operational processes.

In the current environment investors have tended to either favour high-yield, low-growth securities (bond proxies) that offer defensive characteristics or have sought the other end of the investment spectrum through low-yield, high-growth securities that offer exposure to a recovering economic environment. As a result, both ends of this spectrum have become expensive. We tend to look for fund managers who have preferred to seek opportunities among securities that offer a reasonable combination of yield and growth – where we believe the most attractive valuations exist. These securities offer both a degree of downside protection as well as upside growth potential.

The liquid nature of the global listed infrastructure asset class also allows the manager to adjust the portfolio to reflect views regarding the economic outlook. This is a key benefit of active management, which helps mitigate risk by adjusting exposure to specific companies with a secondary overlay of macro views regarding specific sectors.

The long-term outlook for global infrastructure securities is attractive, as investor interest has increased dramatically in recent years. Large-scale trends such as population growth are anticipated to spur infrastructure spending worldwide and drive stable returns for decades to come.    

Ryan Friedman, head of Multi-Manager Investments, Investec Wealth & Investment