Building a robust portfolio with infrastructure
Gavin Peacock, Senior Research Analyst at CBRE Clarion Securities.
Paul O'Connor: Welcome to the Netwealth Portfolio Construction podcast series. My name is Paul O'Connor and I'm the head of investment management and research at Netwealth Investments. In my role, I manage and govern the investments that we make available to you through the Netwealth Investment platforms. Today, we have Gavin Peacock Senior Research Analyst with CBRE Clarion Securities. Welcome Gavin.
Gavin Peacock: Thanks Paul. Nice to be on the show.
POC: Nice to have you here. Clarion or CBRA Clarion have a, I guess a joint venture with UBS, where they're the underlying fund manager on the UBS Clarion Global Infrastructure Fund and we have that fund and a number of other UVS funds available to our investors on the Netwealth platforms. I thought we would discuss with Gavin infrastructure investment opportunities and really what is attractive about the asset class. So starting with the first question, the listed infrastructure market has grown significantly over the last 20 years. So can you explain to the invest... Listener, what is infrastructure and what is driving the growth of the asset class?
GP: Thanks Paul. Well, global infrastructure is broadly defined as high value physical assets that are vital to a country's economic development and prosperity, and we think about infrastructure, we break it down into four main categories. There's communications infrastructure, things like towers, fibre and data, pipelines that tend to transport gas and oil, utilities that are distributing energy, gas and electricity, and of course the transport spectre. So things like toll roads, airports, ports and rail. Now each of these individual sectors have got their own characteristics and drivers. But what really draws them together is a number of positive common characteristics. And I think... So the few main ones we want to point out today, the fact that they do have very high barriers to entry, these assets tend to be very monopolistic in their nature.
POC: So very difficult for a competitor to set up, and I guess the toll roads a great example.
GP: Exactly right.
POC: You're not going to get a competitor building a toll road, right next to another toll road.
GP: Very hard to do that. That's right, and then with that comes pricing control as well, so that's a very attractive attribute. They tend to have very consistent levels of demand. So these, these assets are essential assets that the people want to use them regardless of what's going on in the macro environment or cyclical drivers. And they tend to have very defined longterm revenue streams as well. So they tend to have regulated or longterm contracted cash flows, which are often linked to inflation, provides a protection for that perspective.
GP: And the beauty of all those three factors that does provide very predictable growth for investors with recurring cashflow streams coming back to their end owners. And to tier point around where's the growth coming from? Well the beauty of infrastructure assets is that they age over time, they constantly need reinvestment, need to be upgraded for safety, reliability or efficiency purposes and so that need is there regardless of what's going on in the macro or political environment. And that provides great opportunities for reinvestment for investors.
POC: It's interesting I guess, Gavin, I've found in personal experience no matter where you travel, you see that need for the different areas of infrastructure investing and build out, for example, you go to the U.S and you see how old a lot of the airports are, the bridges are, the roads are, and it would vary across each country, obviously an emerging country would have a different need in terms of it's infrastructure, but I guess it's an investment opportunity that we can really see and we touch on daily in our lives.
GP: I'd add to that as well, one of the other great features about it is the fact that you do get a certain level of return when investing in the asset class. So you think of a Transurban in Australia for example, and when the Victorian government wants to expand some of their road network and potentially put an extra lane on city link, they go to Transurban and negotiate basically a price for that, the capex that Transurban's going to spend. So they get a concession extension or some form of price increase or toll increase. So when they're spending that first dollar investment on that additional road, they already know the return they're going to get on that investment. And I think that's quite unique to infrastructure versus many other asset classes.
POC: And I guess to a degree it then sort of gives it an attribute where it's regarded as a lower risk top of security compared to the broader market investing. So what are some of the broader attributes of the listed market and the listed infrastructure market as opposed to the unlisted infrastructure market that makes it so attractive?
GP: Well, a number of strong attributes, I think if you look over the last... One of them would be performance. If you look over the last 15 years, the listed market from a global perspective's been able to deliver a 10% return per annum. That's obviously very attractive versus many other asset classes available and it gives a good yield. We live in an environment today where bond yields are very low globally. The average bond yield in across the globe is around 1.3 today in Australia, the 10 year bond yields at 1.2 in parts of Europe, yields available from government bonds are sitting below zero in some cases. So the, the three and a half percent dividend yield you're getting from global infrastructure is quite attractive. And there's also some inflation protection, 85% of the assets have some form of annual indexation or inflation linked leases. So that does provide price growth every year.
POC: I think finally the fact that there is... These are essential assets so they do tend to have demand for them regardless of what's going on in the macro environment that flows through to the lack of level of volatility of their earning streams over time. The final point I'd make is that the city infrastructure does provide a very good diversifier for clients' capital. The correlation between global infrastructure and bonds is around 0.4 and against global equities around 0.6 so when you consider the total returns the asset class has been able to provide, it does provide good diversification whilst not sacrificing on that total return.
POC: Yeah, I've found, you know, a lot of the increased interest on the Netwealth platform in the infrastructure is really about getting that yield and given how low cash rates and returns in bank accounts are for investors. I think that's where... That's probably driving a fair bit of the growth behind it. So what themes are you actually seeing across the global infrastructure market today? And you mentioned earlier the different I guess underlying core exposures with the new infrastructure, can you give us a couple of comments around themes that you're seeing?
POC: Well, so I guess what you're saying at the moment is that infrastructure being an asset class that's typically generated a large portion of its return as a dividend. Will also potentially offer some growth opportunity over the short term given that differential in pricing between the unlisted or private infrastructure asset versus the listed Infrastructure asset.
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GP: Certainly the sector gives you a good return from a dividend perspective, we do see good growth as well. We expect around seven, seven and a half percent growth in next couple of years out of the asset class. So, that's a good attribute. But the final element and to your point is that we do see multiples being able to be increased in coming years, just given that disconnect between the two sectors, and a recent anecdote here in Australia, which might be helpful for some of your listeners, is Hobart airport Aborigine airport down in Tasmania, sold a couple of months ago to a Dutch pension fund and also QIC a super fund here in Australia, direct infrastructure investors, and that sold on a 26 times multiple. And if you compare that to where Sydney airport, the listed the city infrastructure company trades today around a 20 times multiple. So that valuation gap is, is quite stark.
POC: Yeah, interesting. So I'm assuming then in terms of the analytics you wanted to take on your investment opportunities, you do have a close look at the non-listed infrastructure market given you've already referred to it a couple of times and you're looking for differential in pricing and in higher investment opportunities.
GP: Yeah, it's very, very important. We think a private infrastructure investors are the marginal buyers of assets in the asset class and it's very important to have an understanding of what they're doing. We're very fortunate as part of our platform at CBRE to have the Caledon business, which is a direct infrastructure platform, which was bought by CBRE a number of years ago and we incorporate them very heavily into our investment process to get a perspective of, you know, the types of pricing and IRR's that direct infrastructure investors are underwriting when they're investing in different asset classes across the market. It's very helpful for us to get a perspective on some of the regulation risks in the different markets that they operate in and get us a second perspective on that. So that's quite [inaudible 00:11:57], and the other final point is just to getting a perspective on where the capital flows are moving towards, and we really have seen a move away from, many of what has been seen as traditional infrastructure asset classes into some emerging new infrastructure asset classes, which we see as being quite exciting going forward.
POC: Yeah, interesting. Well, I mean touching on the emerging asset classes. There are I guess, you know, everywhere we look we see in terms of I guess major themes in the market being around big computing and the whole explosion of data and data usage and analytics, but then also increasing focus and discussion on clean energy production. Are these things, providing any investment opportunities in your world, in the list of infrastructure world and what sort of earnings outlook and scope for dividend growth would these investments offer?
GP: Data is the fastest growing commodity in the globe right now there's an interesting stat that all of the data that's been created through time has been created in just the last... Sorry, 90% of all the data that's being created through time has been created in just the last two years. So it really shows that acceleration of data usage around the globe, and it makes sense when you think about how where we've gone to now streaming movies straight to our phones, we're storing our photos and our files straight up on the cloud and we think about how that's going to grow in the future, and as we move towards driverless cars, you know the amount of data that's likely to be required as cars need to communicate with each other and road furniture is likely to continue to increase as well.
GP: So there's great opportunities for investment for infrastructure companies that are required to, or infrastructure is required to store, to process and also to transmit that data to the end user. So we see opportunities in things like co-location data centres, owners of fibre cable and also owners of teleco towers as well. You know, as they move away from 4G to 5G that's providing a lot of investment opportunity in that asset class. It's important to note that the data sector historically hasn't been seen as traditional or communications has been seen as traditional infrastructure, but we are now seeing many of those... These assets as being essential assets. They're attracting institutional capital, many of them are very hard to replicate and we've seen some big deals happen in that space from private infrastructure funds buying out assets in that asset class. A recent one was Zayo, which is a listed fibre company in the U.S which was taken out by a Swedish pension fund for around $8 billion.
GP: That's right. There's potential for investment into those individual generating assets, but they do tend to have some... The challenge with investing in the individual generation assets, it does have some volatility in what happens with commodity prices, but the attraction is potentially investing in those, infrastructure companies that are connecting, so the transmission lines between those energies, sources through to the end user. That's a great for many of the utilities that operate across the globe.
POC: Yeah, well that certainly is an interesting investment opportunity, but I guess it's not surprising in the fact that natural energy, whether it's wind or whether it's solar isn't necessarily best located next door to an old coal mine so hence you need a complete new infrastructure to get that energy and actually deliver it into the homes of Australians.
POC: Just moving off the actual specific topic of infrastructure opportunities. you work for an active investment management business, what investment style do you think he's best suited to listed infrastructure?
GP: Active question is relevant because obviously we're seeing a lot of investors look to passive index funds in this climate, but we do think the listed infrastructure sector is really a specialist sector where an active manager does have a real opportunity to beat the benchmark and to add value for clients. One of the reasons for that? Is that many of the current indexes that are available today in the infrastructure space we think are restricted. They don't tend to incorporate many of the interesting investment opportunities that I've just talked about previously within that index. So if you think about sectors like data centres, fibre companies and parts of the energy infrastructure space like LNG export terminals, they're currently excluded from many of the major indexes. So you're missing out on some of those really high growth opportunities within infrastructure, if you're just investing in the index and we think they are core infrastructure and we're seeing it in terms of the way that direct infrastructure pension funds are allocating their capital into these subsectors and of course the essential nature of many of these assets.
GP: And so, you know, ignoring those stocks is leaving out quite a big portion of the market, which has good growth opportunities. Our portfolio today, around 35% of our portfolio is held outside of the index. So it really is worth considering that when you think about whether to active allocate to an active or a passive fund, I'd also note that the sector itself, there is quite a number of sectors within it and they do have a relatively low correlation between them. We estimate that the 10 main sectors within infrastructure, have got a correlation of around 0.35% so there's quite a bit of dispergent there and that results in quite a bit of dispergents in performance from any one year rolling basis against one another.
Learn the unique investment characteristics of global infrastructures and why this is an asset class too large to ignore for your portfolio.
GP: So for an active manager that's able to move from one asset class to another with an infrastructure, there is good opportunities to outperform and we've been able to fortunately achieve that over our last seven years of giving around 250 basis points of alpha over that time frame.
POC: Yeah some interesting points you make there Gavin, but I guess the most prevalent one they are in my mind would be the fact that index as in the rules for indexes, can be quite rigid and take some time to actually update and change to move with the actual investment universe as it is growing. So that does resonate the fact that active management can be more dynamic in taking those opportunities as they're appearing.
POC: So how has infrastructure actually performed compared to the broader equities market? So I guess at the end of the day that's what an investor is really there for, the return. What does the return look like against, for example, the MSCI world index.
GP: Yeah versus global equities. Yeah, the sector's done very well. You look over the last, last 20, oh sorry, the last 10 years it's delivered at 12% total return, which is in line with equities and if you look over just about all periods over the last 20 years, the sector's been able to perform in line or even some cases slightly better than the equities market. I think one of the real attractive attributes to the sector though is not just being the positive return that's been able to deliver, but also the defensive characteristics and how it's performed in down markets. And I want to give you an example, if you cast your mind back to the last quarter of the fourth quarter of last year, there was obviously a lot of uncertainty at that time. You had Brexit fears, you had Trump kicking off trade wars with China, and as a result, equity markets were off dramatically. You saw, depending on the asset class equities were off anywhere between seven and 17% over that last quarter of last year.
GP: But if you look at the infrastructure sector over that period, it was down just 2% so it gives a very good level of defensiveness and part of that comes with the fact that the earnings do tend to be more stable regardless of what's going on in the economy. And if we look at downside capture ratios over a longer period of time, so say over the last five and 10 years, the downside capture ratio's sitting around 5% versus equities and what that, sorry, 50% and what that means is, you know, if equities were to be down 10% they now on average over the last five and 10 years, the infrastructure market falls just 5% so half the downside of the equities market and that's still occurring despite the fact that it's capturing most of the upside in up markets.
GP: That's quite an attractive attribute for a lot of investors.
POC: Yeah, absolutely there Gavin and I guess probably in my mind I think of it also, the fact that it is a lower risk type of investment compared to the broader market and if you think about, again back to the toll road example, no matter how the economy's going, the traffic on a toll road is fairly consistent throughout the whole economic cycle. So not only is there no real competitor and there's locked incertainty over the term of the provider actually being able to put a toll on the road, but the fact that the usage is fairly stable over the whole economic cycle.
GP: That's right. I think if you look at Transurban for example through the GSC, I think only one of their, to their toll roads across all of their networks actually went backwards from a volume perspective over that period.
GP: So it shows how defensive that asset class is.
POC: All right now perhaps turning to discussions about yourself, Gavin, sort of interested how you became an infrastructure analyst and you know if you can explain to the listener a little bit about your role and what really fascinates you about the area you work in.
Gavin: Yeah, thanks Paul. Appreciate that. So yeah, I've be working with CBRE Clarion for the last 14 years initially focusing on the property space, but had the opportunity to work in the infrastructure team over the last three or four years focusing on the Asia-Pac region. I think there are some really strong synergies between the two asset classes, property, infrastructure, which has made the transition easier for me. But you know what I like about the sector, I like the tangible nature. I like the fact that it affects our lives every day and I think about my day to day, for example, I live in Sydney, obviously this podcast is being hosted here in Melbourne and when I got up this morning I got up and caught a taxi and I jumped on a Transurban toll road.
GP: I then got off in the airport, Sydney airport caught a plane here to Melbourne and then jumped on another Transurban road into the... To the CBD, and I look at the lights here around us and the electricity that's been used to power those lights and that's being distributed by a company or that we can invest in a called Spark Infrastructure and part of that's also owned by a Hong Kong company that I cover called Cheung Kong Infrastructure and I think about after this meeting, I'm likely to look at my phone and see what share prices have been doing the last hour or so and obviously connected with Bloomberg, the data that's being processed there is likely to be processed in the next DC data centre. So it's touching our lives every day and I think that's really fascinating and very exciting about the sector that I'm looking at every day.
Paul: Yeah. They're real assets and they impact on each and every one of us, every single day, infrastructure. So I can certainly appreciate your comments there. Can you tell me a little bit about, I guess you know the poorer investment cycles that you've experienced in your career and what's been the driver behind them?
GP: Like I'm sure I have an answer that'll be very similar to many people having been in the asset class for the last 20 years or so. The worst investment cycle I experienced was during the GFC, you know, working-
Paul: I can share that comment too and appreciate.
GP: At the time I was working in the UK as a European property analyst and in 2007, 2008 and seeing banks collapsing, credit availability contract dramatically and the knock on effect that, that had for property and infrastructure companies at the time and the fact that they need to do very deeply discounted rights issues and that destroyed a lot of value for investors at the time. That being said though, it did teach the importance of having a diversified balance sheet and I think when I look at the companies today across my coverage universe, it is quite encouraging that many of these infrastructure companies around the globe have learned their lessons from before. You know, they're running with less leverage, they're using a much wider range of debt sources and they've spread out their debt maturities over a much longer time frame to really protect themselves from any sort of unforeseen credit crunch. So I think some of the lessons of the past from that previous cycle have been implemented by the companies today.
POC: And I guess also that on the reverse, whilst I agree that 2008 was probably the worst investment cycle we've experienced or I've certainly experienced in my career, 2009 became one of the greatest investment opportunities.
GP: Of course.
POC: Of my career because of the fact that assets was so sold down and were, I guess, representing such great value.
GP: Yeah and also because of the recapitalization, the companies obviously had much stronger balance sheets, so they had the capacity to expand through acquisitions in developing pipelines as well. So you're right, it was a fantastic time to invest.
POC: And finally, is there a golden investment rule that you apply to all your investment decisions, this might be a personal one you picked up as a younger person or one that you apply every day in your job that you've learned technically through your studies?
GP: I think both and you know, practically implementing this as I operate as an analyst and one of them is to I think always be willing to change your investment views as the facts change. It's very easy in my role to fall in love with stocks you spend a lot of time analysing the companies, meeting with the management teams, touring the assets and modelling the company. So it takes a lot of time to get conviction into stock, but it's very important for a good analyst to be disciplined and when the facts change and that investment case changes to be willing to cut a stock and to change your view and I think that is a very important rule when you're thinking about investing in equities around the globe.
POC: Yeah and it is very difficult, I think, to fully address that being that humans by nature, we tend to get very close and almost fall in love with, you know, the investments we're holding and want to believe that they can come true. But I fully agree the best investors that I've come across, try and keep a very dispassionate view over the investments that they've recommended and are holding in their portfolios, so... Well, thank you very much there Gavin, for joining us today, we do appreciate it and thank you very much to the listener for joining us for the Netwealth Portfolio Construction podcast series.