Essential assets: The case for listed infrastructure

Essential assets: The case for listed infrastructure

Benjamin Morton

Head of Global Infrastructure

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27 minute read

September 2023

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Investors’ search for diversification and inflation protection has put a spotlight on infrastructure, made brighter by massive public investment programs and the accelerating transition to a digitized, decarbonized economy.

KEY TAKEAWAYS

  • A growing asset class with a compelling track record
    Infrastructure’s regulated, concession-based or contracted revenues and inflation sensitivities have historically resulted in competitive returns, low volatility and strong performance in periods of higher-than-expected inflation.
  • A diverse universe supported by structural growth trends
    Infrastructure companies are leading the charge in clean energy, supply chain modernization and the digital economy, creating potential long-term opportunities for growth.
  • A liquid complement to private assets
    A listed infrastructure allocation can provide access to diverse assets that may not be readily available through private investments, while also offering liquidity to aid in managing and rebalancing portfolios.

A growing asset class with a compelling track record

Demand for infrastructure investments, both listed and private, is at its highest level on record. Assets in dedicated listed infrastructure products have reached $111 billion globally, while managers of private
infrastructure funds have raised capital. In fact, private managers are now sitting on nearly $350 billion in dry powder—cash on the sidelines, looking for suitable investments (Exhibit 1).

While historic public infrastructure spending programs have raised the public profile of infrastructure as an asset class, we see several fundamental factors driving demand for listed infrastructure allocations, including:

  • Appetite for infrastructure’s attractive historical investment attributes, including the potential for strong total returns, reduced volatility and inflation protection
  • Access to critical forces driving economic change, including infrastructure modernization, digital transformation of economies, decarbonization, and investments in logistics assets
  • Acceptance that listed infrastructure may be an effective complement to private infrastructure investments, offering diversified exposure with access to assets and industries that may be less available to private investors
EXHIBIT 1
Infrastructure demand is near an all-time high

US$ billions

Infrastructure demand is near an all-time high

A historically attractive return profile

Listed infrastructure has little overlap with broad equity allocations, accounting for just 4% of the MSCI World Index, and provides access to subsectors and investment themes that are typically under-represented in broad equity market allocations.

Performance data over the past 17 years (since index inception in 2006; Exhibit 2) indicates that listed infrastructure offers the potential for:

  • Competitive performance relative to global equities, with total returns averaging 7.2% per year
  • Lower volatility, supported by the relatively predictable cash flows of infrastructure businesses
  • Improved risk-adjusted returns, as measured by a higher Sharpe ratio
  • Resilience in down markets, with infrastructure historically experiencing 74% of the market’s decline, on average, in periods when global equities retreat

In 2022, in an environment characterized by slowing growth, rising interest rates and high inflation, infrastructure substantially outperformed broader stocks. This was consistent with infrastructure’s history of resilience and relative outperformance in most equity market declines (Exhibit 3).

EXHIBIT 2
A favorable return profile

Performance statistics, 2006-2023

A favorable return profile
Infrastructure outperformed in 9 of last 11 market declines
EXHIBIT 3
History of resilience in down markets

Global equity market declines >5%

History of resilience in down markets

Beneficial inflation characteristics

Infrastructure has historically delivered strong relative returns during periods of higher-than-expected inflation, compared with modest or negative relative performance for stocks and bonds (Exhibit 4). This positive sensitivity has resulted from inflation-linked pricing mechanisms in many infrastructure revenue models, which provide for contractual adjustments to user fees. These adjustments may be based on fixed increases approximating inflation or on variable increases linked to consumer or producer price changes (see inset table). Furthermore, certain subsectors—particularly in transportation infrastructure—may benefit from rising throughput in a strengthening economy.

EXHIBIT 4
Strong relative returns in inflationary periods

Inflation beta, June 1991–June 2023

Strong relative returns in inflationary periods
Interest-rate reactions historically followed by strong relative returns

Rising interest rates can pose a near-term risk to infrastructure performance, as sharp increases in Treasury yields may cause an initial negative reaction. However, following rate-driven pullbacks, infrastructure has historically outperformed global equities over the ensuing 3-, 6- and 12-month periods, as the benefits of stronger economic growth and inflation were eventually reflected in revenues.(1)

Providing essential services

The return profile noted above is the result of fundamental characteristics of infrastructure businesses:

Through listed infrastructure companies, investors can gain access to a globally diversified portfolio of infrastructure assets valued at about US$4.5 trillion, spread across the Americas, Europe and Asia Pacific. The investment universe contains a broad range of subsectors spanning four main categories:

Active management opportunities

Each infrastructure subsector has distinct supply and demand drivers, resulting in a wide dispersion in returns in a given period. Since 2017, the difference between the best and worst subsector calendar-year returns were mostly between 30% and 40% (Exhibit 5). Differences in returns are typically even greater at the security level. This wide range in outcomes offers active listed infrastructure investment managers an opportunity to take subsector-level positions with high conviction—which may enhance the performance of portfolios.

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EXHIBIT 5
Subsector return dispersion indicates potential for alpha generation

The spread between the year’s best- and worst-performing subsectors has averaged 35%

Subsector return dispersion indicates potential for alpha generation

A diverse universe supported by structural growth trends

We believe this asset class is positioned to benefit from four distinct long- term investment themes:

  1. Decarbonization driving a global transition to renewable energy
  2. Digital transformation affecting nearly every industry
  3. Logistics assets that facilitate global movement of goods
  4. Infrastructure modernization in both developed and emerging economies

Decarbonization

Renewable energy has strong political and regulatory backing, while declining production costs for solar and wind have allowed these technologies to become cost-competitive with coal, gas and nuclear generation. We believe increased reliance on green power should create opportunities for owners
of solar and wind assets, as society maintains a balance of traditional and renewable energy sources, with a “more of everything” approach having become more accepted.

Wind, solar and biomass’s current share of global power generation is only slightly more than 10% today, but it is expected to rise to 29% by 2040 under current policies (Exhibit 6). The International Energy Agency estimates that figure could reach 49% by 2040 if additional sustainable policies are adopted. Increased government support could improve potential returns for developers and investors while likely accelerating the pace of the transition.

EXHIBIT 6
The accelerating transition to renewable energy

Significant growth opportunities exist for electric utilities and renewable energy developers

The accelerating transition to renewable energy
EXHIBIT 7
Mobile data expected to quadruple

Growing data intensity will require major investments in wireless networks and data centers

Mobile data expected to quadruple

Digital transformation

Virtually every industry is moving to build out digital platforms, and the expansion of artificial intelligence (AI), in its early innings, appears poised to be the next key long-term driver of this trend, on top of 5G demand. AI automation and broader enterprise and consumer adoption will likely require greater investment in wireless networks.

The rapid expansion in data usage in the late-4G environment, coupled with the expected urgent demands of the approaching 5G era, will likely require massive investments to expand communications infrastructure capacity over the next decade. Industry estimates show potential for a nearly fourfold increase in global mobile data traffic by 2028, with 5G networks expected to carry more than half of all traffic (Exhibit 7). This growth will likely support demand for cell tower and data center services and assets for years to come.

Access to logistics assets

The infrastructure universe is well-represented by companies with assets that help move people and goods around the globe—most specifically, railways, marine ports, airports and toll roads operators. They form a critical part of the global supply chain, facilitating the flow of products ranging from semiconductor chips and medical supplies to everyday household items.

Logistics operators stand to benefit over time from factors such as increased operational efficiencies, e-commerce trends, and the strategic onshoring of industrial activity. Freight railway owners, for example, appear poised to continue to see improvements in operations and higher capital returns, potentially increasing company free-cash-flow generation over the next several years.

Infrastructure companies that focus on people and goods logistics account for as much as 30% of leading infrastructure stock indexes.

EXHIBIT 8
Global infrastructure spending fervor

Spending programs supporting growth strengthen an already attractive environment for infrastructure businesses

Global infrastructure spending fervor

At June 30, 2023. Source: Cohen & Steers.

Infrastructure modernization and urbanization

The need for and provision of critical, essential services can create potential return-generating investment opportunities—and the necessity for infrastructure investment is both substantial and global. In developed markets, critical upgrades are urgently required to address deteriorating service quality, from dangerous lead levels in city water supplies to derailments of freight and passenger trains. Governments around the world have either proposed or enacted infrastructure investment programs approaching $3 trillion, seeking to drive a sustainable economic recovery and reduce carbon emissions (Exhibit 8).

In the U.S., we see several potential benefits from infrastructure spending:

  • Direct benefits for renewable energy developers and electric utilities, primarily through tax incentives
  • Potential for new revenue opportunities for cell tower and data center companies due to a larger addressable market for wireless carriers
  • Added boost to economic growth prospects, potentially supporting many segments of listed infrastructure (particularly logistics sectors)

Meanwhile, emerging economies frequently need critical investment to support demographically fueled economic growth, expand urban capacity and meet the demand for higher standards of living. The U.N. projects that the world’s population will expand by roughly 10% this decade and by more than 25% by 2050, driving the need for additional infrastructure.(1)

A liquid complement to private infrastructure

Listed infrastructure is a compelling way to invest in a rapidly growing sector of the global economy, combining attributes of private infrastructure investments with additional potential benefits.

Liquidity and daily pricing

Private investment lock-up periods can exceed 10 years. By contrast, listed infrastructure securities trade on public markets in real time. This allows managers to potentially capitalize on dislocations that may occur in listed values, as well as to efficiently manage allocation changes.

Diversification

Private funds often invest in just a handful of assets concentrated within a few geographies and/or subsectors. Listed investments offer greater diversification—even at the security level. For example, utilities often own
dozens or more assets, which may be spread across multiple geographies.

Corporate Governance

Listed companies are subject to oversight by regulatory agencies, which require strict standards of corporate governance, financial reporting and information disclosure. In the U.S., the Securities and Exchange Commission requires quarterly statements as well as detailed supplementals. The adoption of best practices in corporate governance can align managers’ interests with those of shareholders.

A large opportunity set

The number and variety of infrastructure assets available for private investment are fairly low at any point in time. According to Preqin, the average private fund, for instance, holds around eight investments, versus more than 60 in a listed infrastructure strategy. Moreover, some subsectors (notably airports, railroads and digital infrastructure) aren’t typically available to private buyers. A listed infrastructure portfolio can offer exposure across a wide range of sectors, geographic regions and market capitalizations.

A potentially attractive entry point for allocations

As awareness of listed infrastructure’s potential benefits has grown, so too have allocations from both institutional and retail investors. Further, while infrastructure has long appealed to those seeking diversification and stable income, the asset class’s positive inflation characteristics are now providing an additional incentive amid $30+ trillion in global monetary and fiscal stimulus enacted since the Covid outbreak in early 2020.

Given rising inflation risks, uncertain return prospects in fixed income, and growing concentration in equity markets, we believe this is an attractive opportunity to allocate to global listed infrastructure.

Reasons to consider listed infrastructure:

A differentiated performance profile
• History of strong relative performance in inflationary periods
• Potential to improve long-term risk-adjusted returns and reduce downside risk during equity market declines
• Potential for 3–4% dividend yield and 4–6% long-term cash flow growth(1)

Compelling investment themes
• Historical underinvestment in infrastructure has led to critical deterioration in service quality, requiring both public and private capital investment to modernize assets
• Digital transformation affecting nearly every industry, driving long-term growth for cell towers and data centers
• Utilities and renewables developers positioned to benefit from growing support and competitive costs for clean energy investments
• Transportation sectors such as freight rails and marine ports essential to solving the world’s evolving supply chain needs

An attractive complement to private infrastructure
• Ease of implementation at a time of record dry powder in private infrastructure funds
• Opportunities for global diversification within an infrastructure allocation
• Benefits of liquidity and the oversight of public markets

ABOUT THE AUTHORS
Author Profile Picture

Benjamin Morton, Executive Vice President, is Head of Global Infrastructure and a senior portfolio manager for Cohen & Steers’ infrastructure portfolios, including those focused on master limited partnerships.

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