Traditionally, bonds offer a reliable income in a portfolio and some ‘ballast’ in the event of share market volatility. However, they can be vulnerable as interest rates rise, as has been shown recently. If the tightening cycle is broader and longer than expected, bonds, especially longer dated and more highly rated debt, could lose more capital value.
For investors seeking income, or a stable component to a portfolio that offsets equities, infrastructure investments could help offer an alternative. Infrastructure provides the essential and services to support economic and social activity, for example electricity, gas, water, transportation. Assets typically have an important strategic position and face less competition, so they may enjoy more predictable cashflows. Importantly, infrastructure companies can often raise prices without affecting demand much, plus contracts generally offer the ability to increase them with inflation meaning cash flows automatically adjust to higher prices in the wider economy.
Reliable income streams, but a complex area
Assets such as roads, power networks and public buildings are often backed by long-term revenue streams from local or central government. A motorway river bridge can, for instance, represent a near-monopoly route, and may have scope for raising toll prices over time, albeit there can be occasions, such as during the Covid pandemic, when demand falls away.
Meanwhile, revenue from water, gas, broadband and other essential utility infrastructure tends to be fairly stable, and the provision of key buildings such as hospitals, schools and prisons are often uncorrelated to the wider economy altogether.
Although a long term asset, infrastructure is constantly evolving and presenting new opportunities. The transition to net zero carbon calls for huge investment in new, more efficient electricity generation, storage and transmission, not to mention the huge roll out of charging points that the widescale shift to electric vehicles will bring. Meanwhile, heavy investment in high speed broadband is still necessary, notably in large swathes of the US.
However, it can also be a complex area and there are a number of risks to consider. Due to local or national importance, key infrastructure is often highly regulated. Although governments are often reliable, long-term partners, there is always the possibility they can intervene and, in extreme cases, reduce or constrain an investor's return, for instance through revoking licences, nationalising assets or projects or changing legislation.
The value of investments, and the income derived from them, can fall as well as rise. Investors may get back less than invested.
Investing in infrastructure company shares through a fund
One route is to invest in shares of companies that operate infrastructure or vital utilities. Picking individual shares can lead to a lack of diversification, so another option is a fund specialising in these. They should offer a broad range of holdings by sector and geography while still producing a decent income from a flow of underlying dividends.
One option our Collectives Research Team rate highly in this area is FTF ClearBridge Global Infrastructure Income Fund. The management team are experienced infrastructure specialists based in Australia and have built an impressive record whilst consistently delivering a decent yield, though past performance is not a guide to the future. The fund invests in shares of companies around the world operating in infrastructure related sub-sectors. The fund is exposed to both regulated assets (gas, electricity and water utilities) and to ‘user pay’ assets (toll-roads, airports, rail and communication towers).
Around 90% of underlying revenues in the portfolio are inflation linked, so the portfolio could be resilient in a scenario of higher inflation. However, it may be more vulnerable if economic activity drops off, particularly in respect of companies with ‘demand-based’ revenues, such as toll road operators and airports. The historic yield is around 4%, but please note this is variable and not guaranteed.
About the fund
Although this fund started life in July 2016, the team have been managing infrastructure assets for much longer and have a successful record versus peers and a fairly low correlation to wider global equities. Performance should be assessed relative to other listed infrastructure peers given the specialised nature of the fund and not the broader global equity market.
The management team look to invest in the services and facilities necessary for an economy to function, owning 'hard' infrastructure assets around the world. The fund does not invest in companies with direct commodity price exposure and can underperform when these sectors are fashionable.
The process starts with an evaluation of the macroeconomic scenarios and risks. The team use an external model to provide long term forecasts for GDP, inflation and long and short term bond yields or interest rates for each country that that the fund has exposure to, with the team's judgement overlaid onto the model's views. They then analyse the companies in their investible universe, examining the company's regulatory burden, its valuation and the fundamental and ESG (Environmental, Social and Governance) risks.
Valuation analysis is based around a discounted cash flow model, adjusted for various factors such as the correlation of the stock's local sector versus its global index, the stock's liquidity (ease at which it can be traded) and a qualitative 'comfort factor' applied by the portfolio managers. Estimated valuations are set according to what the team expect bond yields, interest rates and economic growth will be in five years’ time.
Stocks are ranked between 1 and 4 with position sizes varying according to the ratio of expected to required return for a company. The cheapest stocks will have a maximum position of 6% in the fund, the smallest a 3% weight. The managers will increase and decrease a stock weight as either its expected or required return level changes. The majority of the strategy is in mature assets (between 0 and 70%) with a maximum of 20% in both developing assets and greenfield assets.
The fund will typically be largely invested in regulated utilities (50 to 90%) and transport assets (0 to 45%) with some in communications (0 to 20%) and social infrastructure (0 to 20%). Geographically, it will be mostly invested in Developed Europe, Australia and America, with up to 20% in Emerging Markets.
The Sydney-based investment team was integrated into ClearBridge in 2020 and remains independent, the business having been acquired by Franklin Templeton in 2020. While they leverage the parent company’s investment research platform and risk function, they have autonomy on investment decisions.
The global infrastructure sector has been growing for many years and is expected to continue getting bigger. For income investors especially, it remains an interesting alternative to more traditional components of a portfolio owing to the resilient, long-term, visible nature of cash flows, in-built inflation protection and low correlation with the stock market and economic cycle.
There is an element of political risk to bear in mind, and at a single company level there are a myriad of variables that can impact operations and profits. As with any investment area, diversification makes sense, and we believe this fund is a sensible and well managed option in this regard. There is also the general risk that assets with reliable income streams have become expensive in an era when yields generally are on the rise owing to higher inflation and interest rates. Should bond yields rise further, that might only be partly mitigated by any inflation protection at a project or company level.
In recognition of the highly experienced and well-resourced management team, we have now added this fund to our Direct Investment Service Preferred List. Compared with other options in the sector it is very much income-orientated with a higher dividend yield than peers. The strategy has a structural tilt towards income-generating regulated utilities (minimum 50%) but also maintains the flexibility to invest in more growth-oriented infrastructure assets which offer the additional benefit of inflation-protected capital growth. We think this a high-quality option for investors seeking high income and exposure to the broad and varied listed global infrastructure asset class.
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