Generating income and capital growth with unlisted infrastructure

Rory Shapiro, Associate Director at AMP Capital

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Accessing unlisted infrastructure, like airports and toll roads, can be challenging due to the large capital outlay required. In this episode, we chat with Rory Shapiro, Associate Director at AMP Capital, to explore how investors can generate cashflow with less volatility using unlisted infrastructure. Learn how infrastructure responds to rising inflation and discover the outlook and emerging opportunities in the sector.


Paul O’Connor:

My name is Paul O'Connor and the head of Investment Management and Research. Today, we welcome Rory Shapiro from AMP Capital, who was a member of the AMP Capital Infrastructure Equity Team. AMP Capital has three decades of experience in infrastructure asset class and has invested significantly in resources within the global infrastructure business, including personnel with operational and transactional experience. AMP Capital's infrastructure type manages 21 billion in direct equity infrastructure investments as of 31 December 2020 across the key markets in Australia and New Zealand, Europe, and North America. Rory is an associate director in AMP Capital's infrastructure equity team and has been with the manager for six years.

Rory works across the full lifecycle of infrastructure investment, participating in portfolio management, deal origination and asset management. He's the portfolio manager of any institutional infrastructure fund and the assistant fund manager for the AMP Capital Core Infrastructure Fund, which provides retail investors with access to our listed infrastructure director.

Unlisted infrastructure is a mature asset class used by many investors. And Australia has a long history of investing in and managing infrastructure assets. Infrastructure has long been viewed as a low a volatile investment with similar characteristics to direct property.

Even as it provides regular income with some potential for capital growth. However, the last 12 months to challenge some infrastructure assets due to their reliance on the consumer, such as toll roads. So, it will be interested to hear Rory's views on what areas have been the most and least affected by the Covid induced economic slowdown.

Also, given the ongoing debate about whether the recent rise in inflation short term due to supply constraints or structural. I would be interested to discuss how structural rise in inflation leading to a rise in interest rates could impact on infrastructure assets.

So perhaps to commence. Rory, can you explain to the listeners how you came to be managing direct infrastructure assets with AMP Capital?

Rory Shapiro:

Yeah, sure. So, my background in terms of what I studied was it was I did an engineering degree and a finance degree and through that.

I was able to work on some large projects in my final year of university, and one of those was essentially a giant project in Saudi Arabia, and I was working on that based in the Houston office of a big chemical company.

And so, from that, I got a good feel of, you know, working on projects and found it quite exciting. So, when the time came, I found infrastructure to be attractive because obviously, you know, and infrastructure investment using that finance background and that finance knowledge.

But also, you're working on acquiring or managing big complex projects in the form of infrastructure. So, it's always, always interesting. Always lots to think about and lots to do in case.


That’s a very interesting double major at university, doing both engineering and finance. That I can appreciate would give you a good appreciation of the actual asset and the actual funding of that, too. So, I, um, I can see how those two skill sets would come together to be to be working on infrastructure.

Infrastructure plays an important role in many institutional investors’ portfolios and is increasingly popular among retail investors. Given some listeners might not be familiar with the asset class. Do you mind explaining what kind of assets AMP Capital's private infrastructure funds invest in and the sort of benefits that infrastructure more broadly playing in a diversified portfolio?


Yeah, sure. So, when we look at infrastructure, our high-level definition is that an infrastructure asset is an asset that provides or facilitates the provision of essential services that drive economic growth and underpin the day-to-day operations of society.

Now, now, obviously, that's a broad definition. And what we tend to do is or a good way to look at is to split it into sectors. And there's really four key sectors that we look at as. The first is your transport style infrastructure.

So, you know, airports, roads, seaports and even to a certain extent, logistics. And then the next category that we look at is energy and utilities. So, anything from electricity transmission to gas transmission to water utilities. The third that we look at is communications infrastructure.

So that that often involves things like telecommunication towers, broadcast towers and data centres. And then the final category that we look at is social infrastructure. And what we call private public partnerships. And so those are usually. Arrangements with the government where essentially you build operate a facility for a government counterparty and in return, they pay you a fixed quality payment. So, of quite a secure cash flow stream. So really the benefits across infrastructure assets really are derived from the fact that they're providing an essential service. They often have natural monopolies or contractual monopolies.

And therefore, the risk of supply substitution and competition can be lower. And, typically speaking, the impact of, you know, an economic downturn can be lower for an infrastructure asset when compared to some other some other types of assets.

So really, what that that that tends to play out into is quite stable cash flows and low levels of volatility and cash flows linked to inflation at times diversification in a portfolio, because often, you know, the drivers that would say drive a standard stock might not be driving an infrastructure asset, cash flows.

And that goes in hand with the fact that infrastructure tends to have a lower correlation with other asset classes. And so, you bundle up all those benefits together. And that tends to be a reason why a lot of institutional investors have significant exposures, infrastructure within their portfolios.

You know, those four subsectors of infrastructure would have different risk and return characteristics. Some what I mean by that is that some would be more in tune and linked to the economic cycle, maybe around transport and others that are more socially structured would not have any link to the economic cycle.


And so, Rory you probably get some level of diversification within those underlying subsectors. But I guess that is where they can play a role that is not correlated to the typical growth assets in a portfolio and hence will have obviously place application benefits when blended with your typical equities and property.

And the other top of growth assets that investors use in portfolios. So, it certainly strikes me that it can play a very key role, and particularly in toning volatility and producing more reliable income, I guess, through a through a portfolio.

Listed infrastructure provides investors with better liquidity. Does the broader equity market volatility associated with list of assets reduce the appeal from a portfolio construction perspective? And is listed infrastructure assets typically more mature when compared to one listed infrastructure and private infrastructure?


Both invest in the same types of underlying assets. So theoretically, over the long term, you'd expect them to have a similar risk and return profile. But sort of, as you noted, the way that you access the underlying investment it does have an impact on the risks and benefits that you face.

So, for listed infrastructure, you're able to build a diversified portfolio in a short amount of time. And that's largely since the securities are very liquid. You don't necessarily have to buy large portions. But then I suppose the downside or some of the detractors from that are that first, you're subject to market volatility and, you know, potentially the impact of speculation or, you know, other factors on equity values. And then the other downside is that as an investor in a listed infrastructure stock, you don't necessarily have any influence or control over that asset other than potentially turning up at the AGM and saying a few words. Whereas with our unlisted infrastructure, because these assets held long term by large investors, usually they're valued less frequently by independent valuers. And so, they're not they're not valued every day. The policy tends to be that they're valued when there's significant change in circumstances that that could lead to a change in the value of the asset, or secondly, once every six months, at least. And what happens is the independent value, which is usually, you know, a big four accounting firm or something similar, would take the corporate model for that asset, take a long-term view, and then provide a valuation range.

And as a result, with that long term view, I think the value does a better job of looking, you know, through the short term to what the long-term proposition for the asset is. And often that makes sense if you've got a long-term time horizon in your investment.

I think the second advantage is control and the ability to influence. So typically, when you buy an unlisted infrastructure asset, you buy a significant stake. And at a minimum, we aim to have a seat at the board, if not majority control.

And that allows us to work with management and harness our experience to drive outcomes in the asset. So, to give you an example, we across our different funds and investors, we manage investments in about four or five different airports.

We're able to take learnings and apply them to the investment. And that's not something that that as an investor, you're able to do in many listed investments. And so that's a key benefit that we see for unlisted infrastructure in terms of, you know, some of the limitations.

It tends to be the reverse for listed infrastructure. So obviously, unless the infrastructure is not as liquid, a sale process or an acquisition process can take anywhere from three to six months or more to as a result, it takes a longer time to build a portfolio and to sell the portfolio.

Additionally, you need to be able to have significant amount of capital to meaningfully invest in the space. And that's because it's largely been an area that institutional investors have played in. So, the kind of equity stakes that are up for sale, you know, are in the tens and hundreds of millions, if not billions.

The place that we tend to like to play in is what we call the mid-market, which is investments of equity sizes of around 100 million to one billion dollars.

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I guess from your comments, then Rory, I'm thinking to myself that it must be a lot more capital intensive, investing in direct infrastructure, but you can have a bigger influence on the outcome and the success of that asset as opposed to listed market, where, as you've mentioned yet, I guess you're bit more of a passive investor in that listed space. 

So, I think it's an important consideration to the listeners to when they considering what type of infrastructure exposure, they'd lock in their portfolio that listed will obviously give them better liquidity. Um, but perhaps the direct infrastructure asset class will give them a smoother return through the cycle.

And a I guess more of an impact the active management can have on managing those assets. So, it's interesting the observations, I think, that that you're making there


Yeah. And I think I think the other thing to note is that it's not always, you know, one or the other decision.

Our retail fund that we manage, the core infrastructure fund, we that portfolio is a split 50 percent analyst infrastructure and 50 percent listed infrastructure and cash, or at least that's how allocation we target. And we find that the correlation between the listed infrastructure and unlisted infrastructure is, I suppose, low enough that there's quite good diversification benefits from having the two in the same level foliar. So, it's something that that that fund has been benefited from that that split allocation. And I also guess the great benefit of the structure like that is that having liquidity means that it can be readily offered by superannuation trustees without the concerns of offering illiquid assets and then the obligations of a trustee to pay a rollover within a prescribed period.


So, yeah, I think it certainly makes a lot of sense to be blending both listed and unlisted bits together. Then 20-20 was an unprecedented year due to COVID 19, of course, so heavily effecting infrastructure performance. What areas of infrastructure was the most impacted by the economic slowdown?


Yes, so it's been an interesting one and into 2021 as well. Really, if you look at it in the four categories that I outlined earlier, as you'd expect, the hardest hit asset or sector has been the transport.

And that's been largely due to travel restrictions. So, it's. Yeah, that's right. It's a globally the thoroughfare through airports has been significantly reduced. And a pandemic is quite unique in that that it impacts all airports all over the world, pretty much.

So usually what you'd say is, you know, there might be an impact somewhere in the world and it wouldn't transfer to another airport. But really, we've seen obviously a reduction in passenger numbers globally. You know, we saw quick recoveries using Melbourne Airport, which is one of our investments as an example.

We saw recoveries, you know, within a year or two to the previous passenger levels in the wake of SAHS, the GFC, when Ansett went into administration. So, this is this pandemic's being unique in terms of global air travel in that we've seen a broad impact.

And so that's been where I think the most pain has been felt and infrastructure assets, obviously, or all the assets that we manage. And I think in the in the broader infrastructure investment industry have revised forecasts downwards. And so that's within the valuation of the assets.

Now, that outlook, which has been impacted by Covid, I mean, typically what we're seeing is that domestic passengers will recover first and that we expect them to recover to 2019 levels around 2023, and that international passenger numbers will obviously ramp up more slowly.

And we expect them to recover to 2019 levels and around 2027. So that's already in the valuation. And I think that's the positive thing to take from that, is that to the extent that, you know, with vaccine rollouts and learning to live with Covid, to the extent that the recovering air traffic exceeds that, then there'll be upside to those asset values. I think in terms of what's been the least impacted is probably two to sectors. So, the first is the social and public private infrastructure sector, which public private partnership sector, which I discussed earlier.

And that's essentially because those projects tend to have what's called availability payments. And that just means that if you meet key performance index, key performance indicators in your contract with the counterparty, which is usually a government in those assets, then you get a fixed payment.

So as a result, it's not really impacted by passenger numbers or economic growth or anything like that. And so, as a result, those assets have performed to expectation where assets have performed. On the upside is digital infrastructure.

So, things like data centres and fibre optic network networks and mobile towers. And that's just because I think we were always going this way as a society where there was more, I guess, digital interaction. And I think the Covid has accelerated that.

As a result, data usage is going up a lot of workplaces. You know, I think at least at least my office now, especially with the lock down primary way of communicating, is Microsoft teams. So obviously that has had a follow-on impact on the demand for that kind of infrastructure.

So as a result, that those assets are probably doing better than they were or they are doing better than they were pre Covid or at least a big portion of them are. So, it's really been a diverse impact through the different sectors.


And I guess, again, to the earlier comments we were making, there Rory, it's sort of not surprisingly, that transport sector, you know, being and including airports is more linked to the economic cycle and the movement of people.

So, what's your outlook for the infrastructure sector? You'd mentioned before about digital infrastructure and the growth of those assets? Um, is there still a good investment opportunity there or are they still quite high in terms of valuations?


Yeah, sure, so I think that those assets, they still do have a strong growth job growth profile, but they are higher up on the risk return spectrum. And so, I think within all the sectors, there's always going to be opportunities that are more attractive than others.

And our approach is really to just build the diversified portfolios of those sectors. I think that on the transport infrastructure side, as I mentioned, you know, to the extent that we learn to live with Covid more rapidly than expected, I think there could be a surprise on the upside there.

And obviously, I think that there's still going to be a demand for travel. I think international travel is ingrained within a lot of Western societies. So, you know, we're looking in that space and just trying to understand what's happening with Covid past Covid vaccine passports and different vaccines and things like that.

So that'll be an interesting space to watch. I think that through Covid, the lower risk social and PBP side of things has sort of proved its worth. And so, we still see those as an important part of a portfolio generating stable yields through different kinds of economic impacts.

And then I think for as yeah, for digital, it is always something we're looking at. And it's just a matter of understanding the specific risks of each project because that because they all are so different but is a space that we're looking at.


So where are the emerging opportunities seen in the infrastructure, and is the investment universe changing as it's growing? And is the number of investment opportunities increased there? I guess what I mean by that is across those underlying subsectors of infrastructure.


Yeah, sure. So, I think there's a few different types of opportunities. I think investment opportunities are often generated by government privatizations. So globally, government balance sheets are quite quiet, strained. And so, governments still need to be delivering on new infrastructure and improving infrastructure.

And a model that has been effective in New South Wales is what's called asset recycling. So, selling all the infrastructure assets to a private investor like the poles and wires or toll roads in Sydney and New South Wales, and then using that money to invest in new infrastructure so that, you know, opens investment opportunities. I think that's more sort of at least in Australia, maybe a medium term to long term thing. Liberal governments tend to be more in favour of private privatization than Labor. I think the other emerging opportunity is digital infrastructure.

So, you know, before cause obviously there wasn't a need for toll roads to the same extent as there was, you know, horses in cars. So needed roads. But it increased the infrastructure need. And so, it's the same with digital infrastructure.

And so, it's with the need for data centres and that fibre networks, those opportunities continue to emerge with data centres. What's important in what we look for and we don't have any invested in any in Australia, but that we are investing globally, is the stability and the length of the contracts, the counter parties for the other centre, you know, are they reliable? And the switching costs. So, it can be surprisingly expensive to move all your servers from one data centre to another. So high switching costs can really add to, I guess, the monopolistic characteristics of a data centre business.

So that's an area that that we continue to look at.


Yeah, well, I guess the opportunity set across infrastructure develops and challenges that society. And now behaviours change. And as you've articulated with technology, your infrastructure assets. But I think also Putin was the points you made around that.

The more stretched government balance sheets are, the more they are going to want to partner with the private sector on building out infrastructure. These. So, it. Yeah. Yeah. I guess the risk is increasing opportunity that will probably say over the next five to 10 years because of because of those pressures.

Now, I guess moving on to moving on to an issue that's been debated quite a bit across the finance industry. And that’s inflation. So, can you we make some comments around how infrastructure assets perform when inflation is rising?

And can they provide investors with some protection? Even many the structure asset income streams are linked to inflation.


Yeah. So that's our view. A material portion of the investment. So, as we look at and hold have revenue linkages to inflation, which is obviously a positive thing to have in a rising infant inflation interest rate, in a rising inflation environment. Also, there's, I guess, a more implicit link in some of our assets. So, assets that are GDP linked often have an implicit link to inflation with the rationale that. In normal circumstances, when you see a rising inflation, it is often driven by increased demand and increased economic growth, which tend to drive volumes through assets like the airports, toll roads and things like that. Obviously, it's important to think about inflation when building a portfolio because you don't want to lose the purchasing power of your money. So, we look at the inflation linkages when we're considering investing in an asset.

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It's really could be a double-edged sword, though, I guess, Rory, in terms of if we do see inflation rising, that will obviously have an impact on interest rates and rising interest rates. And given a lot of infrastructure assets are a combination of debt and equity.

How could a rising interest rate impact on infrastructure assets?


Yes, so there's a few different lenses that you really need to look at. Look at that three. So, the first is cost of debt. So, infrastructure assets tend to have more stable cash flows when compared to a lot of other asset classes.

As a result, they do tend to have relatively high gearing. And so, if interest rates rise, then all other things being equal, that would lead to an increase in the cost of debt for those businesses. Now, the approach that we take in our investments is we look to hedge out interest rate risk in the long in the long term. And so, what this means is that we essentially enter interest rate swaps where we're swapping the floating leg for a fixed leg. And so, as a result, that that tends to minimize a large portion of the risk for cost and debt, a cost of debt.

So, I guess that's a positive thing. The next say so you wouldn't expect it to be, I guess, infrastructure assets be impacted that much. The only area where they would be is assets where there's a large growth component, which would be funded by debt.

That's because you can't hedge future debt that you haven't taken on yet. And then the other important, I suppose, lens to look at is through the way assets are valued. So, infrastructure assets are valued with what's called a discounted cash flow model.

And essentially all that means is that you forecast out the cash flows into the future and then you discount those cash flows. Now, also, what's used to discount those cash flows is the capital asset pricing model. And I won't go into the details on that.

But one of the key inputs is the risk-free rate, which is basically long-term interest rates. So as long-term interest rates go up, the discount rate goes up and the value of the assets will come down because you're discounting the cash flows by more.

And that's all things being equal. So, there's probably two things to note on this for unlisted infrastructure. First, the independent value is of unlisted infrastructure, as I discussed, take a long-term view. And so, as a result, there is an expectation that interest rates over the long term will revert closer to their long term average. As a result, they've essentially built-in buffers to their discount rates. And what that means is that just because interest rates go up by a certain amount doesn't mean the discount rates of their assets will automatically increase and therefore decrease value.

So, there's that buffer there, which we see as a positive thing. And then the second thing is that a lot of our assets are linked to GDP. So, airports, toll roads, all those sorts of assets. And as a result, in a rising interest rate environment like rising inflation environment, you'd expect to see economic growth.

And as a result, you would expect offsetting benefit to revenues of the business. So, I think the way that we look at it is if you just look at an increase in interest rates, in isolation for costs of debt and for the valuation of assets, it can look quiet, quite a negative picture.

But if your account for the mitigation that we have in terms of hedging debt and the approach taken to the valuation of our assets, we wouldn't expect the impact to be to material.


So, Rory, there has been a lot of infrastructure spending announced by, you know, governments globally as part of fiscal stimulus policies.

So, what does this mean for infrastructure investments?


Yeah, sure. I think really what it will mean is that there should be more supply of infrastructure opportunities for investment in the future, largely, as I mentioned, due to asset recycling.

So, governments likely to sell all the infrastructure to fund new infrastructure. So that will be add more supply, which is a good thing as an investor, because it means, one, there's more opportunities for you to invest in and to it sort of moderates the competition around the finite universe of opportunities that that all investors have.


So, what you see is now a prominent emerging theme we're seeing everywhere across investment markets is ESG. Do you guys consider ESG factors as part of your investment approach. So how do you do this?


Yeah, sure. So ESG is something that we've incorporated into our investment approach, at least for the whole time I've been at AMP Capital, so at least six and a half years, and it goes back much further than that.

The underlying rationale for that is that we believe the assets that have a strong approach to ESG also tend to perform well on a financial basis. So that's makes it a good incentive to really have strong ESG credentials.

And so, there's a few different ways we do it. First way is that each year we do a survey which is essentially benchmarks how ESG monitoring and management and reporting against our peers. And we seek to, I guess, improve our school and our ranking every year by looking at how we can improve our approach to ESG. So, I think at the high level that like we're always reviewing how we're doing compared to our peers and how we can do better at a more granular level. We do it across all our activities. So, when we're looking at buying an asset, when we go to get investment approval from our investment committees, we have a section dedicated to ESG. And we do our due diligence on ESG. So, whether those factors, which are potentially opportunities or whether there's risks. And essentially, we approach that the same way we would any other opportunity or risk. We either price it into our bid or we would walk away from the opportunity because the risk is unacceptable. And then in the assets that we manage, we essentially participate at the board level to ensure that there's a there's a review of ESG considerations, that there's sufficient reporting from management on things like energy usage, that projects which are more energy efficient are considered, say, you know, some of the airports that might be a facility or installing LED lights in a car park or it really crosses the full spectrum. So, we're just active in looking for opportunities to apply that ESG lens.


Rory, thank you very much for the time you've spent on the Netwealth’s Portfolio Construction podcast this morning.

And I guess your comments and your thoughts and your insights into infrastructure. I'd certainly found him fascinating there, and I'm sure that will be of a lot of benefit to the listeners there. And I think particularly then back to the listener in thinking about how infrastructure can be used in a portfolio.

I think some of the relevant comments there around the state, this is the unlisted infrastructure assets. And have I had slightly different risk and return characteristics, and then also the fact of the different subsectors of the infrastructure asset class and some of the growth opportunities in digital infrastructure and some of the challenges the transport infrastructure has faced in recent in recent times. So, it's been valuable.

Thanks a lot. Thanks for time to have you and to the listener. Thank you very much again for joining us on the Netwealth podcast series.

And I look forward to joining you on the next instalment.


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