Over the past 10 years, infrastructure investment has gained momentum among investors such as pension funds, insurance companies and sovereign wealth funds, but to a certain extent, infrastructure investment has hit a crossroads. From one side, the global economy is crying out for more infrastructure investment, but governments still own much of their economic infrastructure directly and are struggling to grow the pipeline of investable infrastructure assets. On the other side, a large and growing number of investors are competing for exposure to a relatively small pool of non-government-owned core infrastructure assets. This has seen transaction multiples increase strongly over the past decade. There is a clear supply and demand imbalance.
INFRASTRUCTURE INVESTMENT TRENDS
Investors typically allocate funds to infrastructure on the basis of its defensive characteristics and inflation-linked cash flows. This trend shows no signs of abating, with 71 percent of public pension funds believed to be allocating more money to infrastructure within the next 12 months.
The combination of increasing allocations and fundraising combined with a limited availability of assets means that asset managers have found it increasingly difficult to deploy capital. The latest figures estimate that $173 billion of dry powder, or unspent capital commitments, is waiting on the sidelines to invest in unlisted or private infrastructure. Exacerbating this capital backlog is scarcity of core infrastructure assets in the direct market and high multiples. Not surprisingly, given the strong flow of investment, a recent investor survey found 59 percent of unlisted infrastructure fund managers see high valuations as the major challenge to capital deployment, while 52 percent of managers believe infrastructure assets are currently overvalued. Furthermore, 81 percent of managers are seeing more competition for assets relative to 12 months ago.
All this points to a market in which it will become increasingly difficult to deploy capital and equally difficult to acquire fairly-valued assets. Surely something has got to give.
Given the current challenges of building an unlisted infrastructure exposure efficiently, we would expect any current allocations to infrastructure are likely to take some time to be deployed (assuming the asset manager displays a level of discipline, in terms of both pricing and infrastructure asset type). In the period during which allocated capital is not invested (directly, or through managers) in the desired infrastructure assets, it may even be invested elsewhere in an investor’s liquid assets portfolio, most likely in a combination of equities, cash and bonds.
We contend the $2.4 trillion listed infrastructure market, as defined by the Global Listed Infrastructure Organization (GLIO) coverage, provides investors with a complementary or alternative investment opportunity that could provide a significantly better fit to their desired infrastructure exposure. This could be in the form of a long-term investment as an alternative to investing directly, or a shorter-term allocation to park capital until funds are drawn-down to invest directly.
WHY LISTED INFRASTRUCTURE
Listed infrastructure companies tend to own long-lived assets that provide essential services to society, such as utilities, energy transportation networks, communications and transportation infrastructure. These assets can offer stable and predictable cash flows supported by long-term contracts or regulation, with monopolistic characteristics and high barriers to entry. The GLIO coverage has shown the asset class exhibits compelling investment characteristics over the short, medium and long terms.
REGIONAL AND INFRASTRUCTURE SECTOR DIVERSIFICATION
Listed infrastructure companies offer investors access to a broad and diversified portfolio of assets across three main regions: Americas, Europe, Africa and Middle East, and Asia Pacific. These will include both developed markets ($2.3 trillion) and emerging markets ($100 billion). In the GLIO coverage (based on country of primary listing), the United States, Canada, Hong Kong, Italy, Japan, Spain and the United Kingdom are heavily represented. This breakdown can be slightly misleading, as most listed infrastructure companies own and operate numerous infrastructure assets located in a number of countries other than their location of listing.
Infrastructure assets tend to fall under four main headline sectors that comprise more defined subsectors. These are:
- Utilities: Electric distribution, electric transmission lines, gas distribution pipelines, renewable energy facilities, water cleaning and distribution systems
- Energy transportation and storage: Long-haul energy pipelines, gathering and processing facilities, liquid terminals and LNG facilities
- Transportation: Airports, seaports, railroads, highways and toll roads
- Communications infrastructure: Telecommunication infrastructure (wireless macro towers and small-cells) and satellites
It is worth noting that global listed infrastructure can access a broad set of investment opportunities across geographies and sectors that, by comparison, may not be available through direct investment. It is also worth noting that, although the listed infrastructure market is large, some assets cannot be accessed. U.S. airports are a good example. Regulatory frameworks and contract structures vary greatly from country to country and from sector to sector, as they are based on and exposed to macro variables in different ways. Diversification can help mitigate risk in concentrated exposure to regional economic conditions and regulations.
Historically, global listed infrastructure has offered an attractive income component as a portion of the overall total returns. The asset class has offered higher yields compared against global equities over a long-period of time. On average, since 2003 global listed infrastructure yielded about 3.6 percent versus 2.6 percent for global equities. Global utilities averaged 4.1 percent over the same period. These regular shareholder payouts are underpinned by higher sustainable cash yields, which provide companies with the opportunity to raise payout ratios if required. This is particularly evident among transportation-
focused companies such as freight rail and highways and toll roads.
SHORT-TERM VALUATION AND LONG-TERM PERFORMANCE
Infrastructure assets with the same economic exposures will respond similarly to changes in the economic environment. However, the types of vehicle in which these assets are held can be valued using different methods. Unlisted infrastructure values are based on periodic valuations which lag current market conditions and are inherently smoothed, or even suffer from autocorrelation. Listed company valuations are subject to daily pricing and are more volatile by nature over the short-term. Of course, this can create opportunities for active global listed infrastructure managers. Putting aside short-term differences in valuation, GLIO research highlights the fact that over the medium to long-term, listed infrastructure offers the very similar performance as unlisted infrastructure, and vice-versa. Many would argue listed infrastructure can act as an excellent proxy for direct/unlisted infrastructure.
Another method to compare unlisted and listed infrastructure valuations is to use EV/ EBITDA multiples. When we look at the global airports sector over a 12-year period, it is clear that a portfolio of listed airports offer better value for the money when compared against transacting individual airport assets. The question of diversification — one asset versus a diverse exposure across a number of assets — and management quality and experience can also be raised here. Many of the listed airports own some of the world’s best-performing assets in terms of quality, passenger volumes and customer experience.
Generally speaking, core infrastructure assets will offer investors predictable cash flows, which are driven by price and volume. Firstly, companies that operate assets in regulatory or concession frameworks often have periodic inflation-linked adjustments, or annual escalators built into contracts. Secondly, economic conditions in a country or region will drive demand for an infrastructure asset. Of course, these revenue drivers will vary across infrastructure sectors.
Effectively, listed infrastructure companies offer liquid access to illiquid assets. The dry powder from unlisted infrastructure funds is now at a record high, and the issue is compounded by a scarcity of core infrastructure assets. In contrast, the liquidity of listed infrastructure enables new allocations to be deployed with a high degree of efficiency. Importantly, liquidity enables active managers to adjust portfolios according to their convictions.
On average, listed infrastructure companies are more conservatively leveraged compared with other types of infrastructure investments that can leverage up to chase excess returns. Of course, extreme levels of debt can alter the characteristics of equity. On average, the listed infrastructure companies leverage in the GLIO coverage lies at less than 50 percent.
ACTIVE MANAGER GROWTH
Global listed infrastructure is a relatively young asset class, but there is a growing recognition it can deliver significant benefits to broader multi-asset portfolios, and targeted infrastructure allocations. The chart titled Growth of global listed infrastructure shows the growth of the active global listed infrastructure active management community over the past eight years. We have seen an impressive growth in assets under management over that period. Looking forward, as the challenges of building a direct infrastructure allocation intensify, more investors will look to listed infrastructure as an alternative route to deploy capital into the quality core infrastructure assets they crave. Following trends we have seen previously in other real assets such as listed real estate, total AUM could easily pass $300 billion in 10 years.
The need for infrastructure investment is a never-ending cycle. Looking to the future, governments will need to offer incentives for infrastructure investment to provide the backbone to boost economic growth. For example, the poor state of U.S. infrastructure is well documented. The latest American Society of Civil Engineers scorecard makes depressing reading across the range of infrastructure sectors. The overall grade for U.S. infrastructure was D+. The story is similar across the globe as the percentage of infrastructure investment relative to GDP has declined for decades. Subsequently, the global infrastructure investment gap has widened with an estimated shortfall of $15 trillion to 2040, according to GI Hub.
Current and new forms of infrastructure investment vehicles will need to develop and evolve to help address this critical issue. In recent years, the United States has seen Yieldcos, MLPs and REITs offer investors exposure to infrastructure with a focus on income. Belgium recently expanded its REIT structure to include infrastructure, India introduced an infrastructure trust and Mexico introduced the FIBRA-E. The opportunity to create a clearly defined “infrastructure investment trust” (or IIT) for critical economic infrastructure could look attractive for governments wishing to attract both domestic and international capital to fill the investment gap.
CONCLUDING REMARKS, EXPOSURE TO GROWTH
Listed infrastructure is a compelling way to gain exposure to a growing part of the global economy, combining the attributes of direct infrastructure investments coupled with the benefits of listed markets — a $2.4 trillion global market featuring liquidity and transparency. Ultimately, a carefully defined core listed infrastructure market is made up of a large number of high-quality infrastructure assets, covering regulated utilities, energy transportation, transportation and communication infrastructure. These assets are mission critical to the needs of the global economy.
We should not forget that most institutions would gladly include these assets within their direct infrastructure portfolios if they were available in unlisted form, so why view them differently because they are listed? The companies that comprise the GLIO $2.4 trillion listed infrastructure coverage have demonstrated desirable investment characteristics over many years and can, and should, play a valuable long-term strategic and tactical role within investors’ broader infrastructure allocation. Investors who ignore the global listed infrastructure asset class narrow their core infrastructure options considerably, which could in turn damage stakeholder returns.
Fraser Hughes is CEO of Global Listed Infrastructure Organization, an organization that promotes listed infrastructure investment.