How do you go about researching investments in the infrastructure sector?
It takes a lot of research to identify the most appropriate infrastructure funds to invest in. I think the starting place really is understanding what are all the different funds exposed to, having a view on whether the return profile looks reasonable relative to what they're doing. You don't want to invest in something that isn't sustainable.
Our typical research process uses a combination of qualitative research, primarily exploratory research techniques, and quantitative research, a more formal systematic process using data, to identify the most attractive investments. When researching infrastructure funds we consider additional elements that include:
What are the risks of investing in infrastructure?
- Reviewing the investment strategy, acquisition policy and leverage used (the use of borrowed funds in the purchase of assets)
- Looking through the portfolio assets to understand which regions and sectors they are invested in and understanding the regulatory framework that the portfolio assets may be subject to
- Reviewing the valuation process that has been used to calculate the fund’s net asset value
- Visits to the sites of the assets in the portfolio
- Meeting management teams and boards of directors to ensure they have the necessary sector experience and alignment of interest with investors.
Infrastructure projects tend to use a lot of leverage. On the social infrastructure side it's not uncommon for projects to have a 90% debt in the structure. That works for social infrastructure projects where the cash flows are generated on the basis of project availability and therefore relatively stable. But you might run into trouble having that kind of capital structure on something like a toll road that may see its revenues collapse in an economic downturn.
Re-financing risk is another related risk and ideally you want to see long-term loan facilities that last the life of a project. Infrastructure assets are inherently illiquid which means they cannot easily be sold or exchanged for cash quickly without a significant loss in value. So the method of accessing the asset class must be considered carefully. We only invest in listed funds that are traded like a stock on a stock exchange, which helps to provide liquidity on a daily basis. This only helps to a certain extent as the daily liquidity of listed funds such as investment trusts may be obtained at the expense of value.
Then there’s the potential political risk, which comes with investing in the social infrastructure. One way to mitigate that is by being invested in areas that are aligned with government policy and the interest rate affordable for the government because the flip side is that if you're in a project that is crippling the government because it's way too expensive, it could get cancelled.
It’s also worth considering the impact that rising interest rates could have on the sector. In the current low interest rate environment income investors are often forced to look beyond government bonds for returns. They have been drawn to infrastructure as a potential source of income as returns are often linked to interest rates making the asset class particularly attractive when interest rate move higher. This can affect the yields offered for making an investment which is something to look out for.
What’s your outlook for this sector?
Governments around the world are increasingly talking about infrastructure investment as a means to stimulate economic growth. Consequently, I think it's likely that there will be increased supply of infrastructure assets that create good opportunities. Despite the fact that we are already going through a period of bond market volatility, with people challenging the ‘lower for longer’ interest rate thesis in the UK, there's still a massive demand from investors for infrastructure. I think this reflects the potential high yields, stable cash flows and positive link to inflation.
If interest rates do rise, it is likely to be because inflation is present in an economy. The large amount of debt in the world makes central banks reluctant to raise interest rates unless they have to because it would have such a negative impact on growth. That should keep investors interested in this sector.
Do you have a particular infrastructure subsector that you are interested in? What makes this stand out?
An area I particularly like is energy infrastructure in the US, for example the pipelines that transport oil and gas from wells to refineries. It’s a high yielding sector with low sensitivity to the oil and gas price because revenues are linked to the volume of oil and gas that is transported through your pipelines. Often they have what's called take or pay contracts where a company will sign up to a specific level of volume and they pay that whether they actually pass it through or not.
I think OPEC’s (Organization of the Petroleum Exporting Countries) dominance in the oil market is ending and that US shale drillers will be a major supplier going forward. Through innovation to reduce drilling costs they have adjusted to a world of lower oil prices and have recently been increasing supply. This should create long-term profitability for the providers of US energy infrastructure.
The value of investments and any income from them can go down as well as up and is not guaranteed, and you could get back less than you originally invested. Past performance is not a guide to future performance. The views expressed within this article are those of Architas, who may or may not have acted upon them.
AXA is a worldwide leader in financial protection and wealth management. In the UK, one of the AXA companies is Architas Multi‑Manager Limited, an investment company that provides access to other investment managers’ services through a range of multi-manager solutions, including regulated collective investment schemes. Architas Multi-Manager Limited is a company limited by shares and authorised and regulated by the Financial Conduct Authority. It is registered in England: No. 06458717. Architas, PO Box 10939, Chelmsford, CM99 2XU.
The views and opinions contained herein are third party and may not necessarily represent views expressed or reflected by Willis Owen.
: we do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.