James de Bunsen, Portfolio Manager on Janus Henderson’s UK-based Multi-Asset team, discusses the solid attractions of infrastructure investment.
Infrastructure investment was previously the preserve of large institutional investors, who prized the sector for its steady and uncorrelated, if unspectacular, returns in relation to other asset classes. While the long term and potentially illiquid nature of infrastructure may have historically made it more suited to pension funds, the growing range of investment opportunities is attracting retail investors.
Any operation or system in the modern, ultra-connected world relies on infrastructure, which, in turn, global economic growth depends on. As with many investments in the ‘alternatives’ space, its profile has grown in response to the era of ultra-low interest rates. Retail investors are increasingly interested in the opportunities presented by a new breed of infrastructure funds, a broad and diverse grouping that encompasses investment in everything from transport, utilities and renewable energy (economic infrastructure) to schools, healthcare, prisons and stadiums (social infrastructure).
We include infrastructure within many of our multi-asset portfolios, primarily because the asset class has the potential to generate very attractive real (above inflation) returns. A large proportion of revenues generated by infrastructure assets have some form of inflation indexing, which is a very appealing feature. UK-listed infrastructure funds have shown they are capable of producing relatively attractive returns in comparison to current UK investment grade bond yields, for example, which yield around 2%*. Moreover, infrastructure can also add attractive diversification benefits to a portfolio. This is especially the case with social infrastructure, where revenues from assets such as schools and hospitals are ultimately backed by the UK government and are not based on any market or economic cycle.
Strong and stable: not all alternatives are the same
When investing in infrastructure funds we look for quality of management and quality of assets. Management must be able to demonstrate a lengthy and relevant track record in sourcing, buying and operating appropriate assets. This seems like an obvious notion but the world of alternatives is full of financiers with clever ideas but not necessarily hands-on experience. Meanwhile, the underlying assets must have the specific attractive features that we are looking for. For the extra diversification benefits we favour social infrastructure projects, given their lack of sensitivity to the ups and downs of the economic cycle. Also, because of their utmost importance to society, we know that they have implicit government backing.
An infrastructure fund that we currently hold is HICL Infrastructure, which focuses on social infrastructure in the UK. The fund launched on 29 March 2006 and since then it has generated an annualised total return of 9.2%, compared to 5.6% from the FTSE All-Share Index**. Correlation to equities has been low (+0.3) and so has the beta (+0.2) over the same period. We believe that this, therefore, makes HICL a true portfolio diversifier and one that is capable of producing an attractive return over time. Finding investments with both these attributes is unfortunately very rare.
We believe future prospects are also good, despite some negative sentiment stemming from the Labour Party’s proposed nationalisation plans, which could include many regulated and infrastructure assets. We believe this eventuality remains a very low probability as polls suggest Labour would not get a majority in Parliament even if there were an election today, despite the crisis in the Conservative Party. Labour would then have to find several hundred billion pounds to carry out their nationalisation plans, at the same time as promising a massive amount of new funding in health and education. Borrowing might be cheap now but with that level of spending on the cards, we doubt lenders in the gilt market would be so accommodating.
In summary, beyond some seemingly remote political risk, we believe that the outlook for infrastructure investments generally appears positive, with strong yields and high quality, more predictable revenue streams. Moreover, its low correlation to equities makes it a great portfolio diversifier.
* Source: Bloomberg as at 14 June 2019 ICE BofAML Sterling Non-Gilt Index.
** Source: Bloomberg 24 March 2006 to 31 May 2019.