Infrastructure has undoubtedly been one of the most coveted asset classes in recent years. The substantial investor inflows are understandable - as the space has historically delivered equity-like returns, but with lower volatility and superior downside relative to the broader equity markets.
In addition, investors have been attracted to the potential predictable cash flows and steady income offered by these tangible assets, which also come with associated inflation-fighting characteristics. These assets, which are the facilities and structures providing essential services to the public and private enterprise, are essentially grouped in four main categories - midstream energy, utilities, communications and transportation.
Due to the compelling characteristics of infrastructure, investors have clamoured to gain access to these assets, primarily through private markets. However, competition for assets is high in the private space, with more than $170bn of capital raised by private infrastructure funds sitting idle. As private capital seeks to invest this ‘dry powder', recent private infrastructure transactions have commanded notable premiums to listed peers.
1. Source: Preqin, Goldman Sachs and Cohen & Steers
This is having a substantial impact on the listed infrastructure space. Private infrastructure funds are increasingly buying assets at substantial valuation premiums. Specifically, recent transaction multiples for private infrastructure acquisitions have averaged 16-18x an asset's projected year-ahead cash flows. This is significantly higher than the 11x average forward cash flow multiple of the listed infrastructure universe. Our point is not necessarily that listed companies will be bought by private funds outright - although we have seen this happen. More so, we are seeing our listed companies selling specific assets to private firms to the extent that the transactions are value accretive. We believe that either transmission mechanism will continue to provide real valuation support to the listed infrastructure space.
Sophisticated investors are beginning to be wary of this frothy private investment environment and are seeking to increase exposure to more liquid listed infrastructure strategies.
Protecting downside amid potentially higher volatility
Aside from the long-term favourable dynamic, the broader macro landscape is also appearing to favour increased exposure to listed infrastructure assets - particularly considering the numerous macroeconomic and political uncertainties currently evident.
After almost uninterrupted gains for equities since the global financial crisis, investors were reminded of the possibility of downside during the volatile stock market of late-2018. The volatility displayed by listed infrastructure, despite offering equity-like returns, is 300bp lower than broader equities over the long term. Infrastructure also has historically offered strong downside protection, capturing only half to two-thirds of the downside of the MSCI ACWI Index during negative market periods. The infrastructure asset class also offers superior income potential than the broader equity market.
In our view, the defensive nature of infrastructure, due to the historical predictable cashflows of these assets, is going to be increasingly important over the next phase of the cycle - as the global economy transitions from what we believe will be above-trend to below-trend growth over the coming 12 to 18 months.
Importance of active management
While the positive structural drivers of the asset class are increasingly accepted by investors, specialist active management in this space is crucial, in our view. The performance differential between the varied listed infrastructure businesses can often be vast, despite these assets sharing similar structural characteristics at a high level.
This is understandable, as there is a wide spectrum of sensitivity to macro factors for the sub-sectors within the infrastructure space. Indeed, a marine port will obviously behave quite differently than a regulated utility in certain environments.
For example, during the financial crisis, dispersion of performance between the sub-sectors - as measured in the difference in performance between the top and bottom performing subsector within the asset class - was about 50% to 60%, and it has been at least 25% every year since. Last year was no different, as the gas utility sub-sector delivered a positive return of 9.5% in US dollar terms, while marine ports fell 16.7%.
Defensive slant on macro concerns
We have taken a more defensive stance within our infrastructure portfolios, given our view of a continued economic slowdown and rising political uncertainties globally. We are optimistic on US water utilities, with growth driven by critical pipeline replacement projects across the country. Consolidation of the largely municipally-owned sector is an additional tailwind.
We also see secular tailwinds for towers. Tower owners are well positioned to benefit from long-term secular demand growth for wireless data services and the adoption of next generation standards - such as 5G - which should drive increases in wireless carrier spending and leasing activity.
Midstream energy is also a favoured subsector, as we believe it is benefitting from two key themes. First, fundamental tailwinds are growing, as North America increases its market share of global energy production. This increases capacity utilisation of existing assets and, in some cases, drives the need for new infrastructure development. Second, management teams are transitioning to what we call the ‘Midstream 2.0' business model. This model recognises the importance of corporate governance and investor alignment, strong balance sheets and return-based performance metrics. While a painful transition over the past several years - a period in which many companies recapitalised and significantly cut distributions - we believe these actions set the framework for stronger performance going forward.
Ben Morton, portfolio manager of the Cohen & Steers Global Listed Infrastructure strategy