Infrastructure in favour despite H1 sell-off

Net outflows of £634.5m as developed market government bond yields spike

Photo by Solomon Hsu on Unsplash

Infrastructure funds have seen outflows for the first time in a decade but this has not discouraged pan-European fund selectors who are big fans of the asset class, according to Last Word Research.

During Q2 2018, 18% of European fund selectors said they were looking to increase their infrastructure allocation over the next 12 months.

Another 30% said they were looking to hold on their current allocations, 3% said they wanted to decrease, and 49% said they did not use the asset class.


Source: Last Word Research

“Of the three illiquid [private equity, private debt, and infrastructure] strategies we look at, infrastructure has the highest number of users across Europe and it is seen very positively,” Last Word Research said.

“There are slightly fewer looking to buy more than in private equity, but there are fewer that are unhappy with the asset class.”

Q1 infrastructure sell-off

According to the S&P Global Infrastructure Index, the sector performed well between January 2016 and January 2018. However, since the start of the year, the infrastructure sector in common with the rest of the market saw a rise in volatility, dropping sharply in late January.

S&P Global Infrastructure Index year to 25 July 2018

Source: FT

Boutique KBI Global infrastructure portfolio manager Colm O’Connor told Portfolio Adviser sister publication Expert Investor that the Q1 sell-off was led by a spike in developed market government bond yields which negatively affected interest rate-sensitive sectors such as listed infrastructure.

He said within the sector utilities underperformed in January and February, adding to the volatility.

“Since February there’s been a slow and gradual pick up but certainly Q1 was a period of underperformance for all listed infrastructure,” he said.

Infrastructure funds domiciled in Luxembourg or Ireland experienced outflows in every month in 2018 except January, according to Morningstar.

Net flows for the year-to-June recorded an outflow of €719m (£634.5m).

This year will be the first time in more than a decade that the sector has experienced outflows if investors continue to sell infrastructure funds during the second half of the year.

The fund that suffered the largest outflows YTD has been Lazard Global Listed Infrastructure Equity fund – which saw outflows of €314.8m.

Europe v US allocations

However, O’Connor argued that steady global growth and slowly rising interest rates should ensure that the infrastructure sector continues to do well in the next few years.

“We think that European utilities are quite well positioned later in the interest rate cycle and stocks are trading at cheaper valuations, multiples, and in many cases set to enjoy superior earnings growth versus US utilities,” he said.

“We certainly prefer European utilities compared to US utilities which we think are quite expensive now.”

For Franklin Templeton Investments director of global real estate and infrastructure securities Wilson Magee more than 48% of investments in his Franklin Global Listed Infrastructure Fund is in North America.

Magee said infrastructure projects centred around natural gas in North America, such as pipelines and export facilities, should flourish.

Challenges for infrastructure

O’Connor added that he was worried that the infrastructure sectors over reliance on the oil and gas industry also carried risks because of the global trend towards green energy and renewables. “Investors need to monitor where their holdings lie,” he said.

“A huge chunk of future energy spend will be on clean energy generation [and infrastructure that supports that].”

He said KBI’s infrastructure focus centred around food, energy, and water, adding that need for water related infrastructure was underappreciated by the market. “Water is an asset class that you can play in listed infrastructure,” he said. “We don’t have any oil and gas pipeline investments.”

Magee shared the view that renewables would play a significant role in future infrastructure developments.

“You now have distributed solar and wind coming into the electrical grid system. The durability of the grids, allowance of inputs, and distribution of power is going to be very important in the future,” he said. “It is a major investment of ours.”

He added that a rise on the global use of renewables will increase the need for base-load power sustainability – encouraging the use of natural gas.

While Magee is therefore optimistic on projects related to renewables and natural gas he is keen to avoid exposure in coal and nuclear power.

“The decline in the use of of coal and to a certain extent nuclear will provide opportunities for gas-based power generation,” he said.

Top infrastructure funds

According to FE Analytics, the top infrastructure fund over the three years to 30 June 2018 was First State Global Listed Infrastructure Fund Class I that returned 15.14%.

This was followed by Franklin Global Listed Infrastructure Fund at 15.06%, Nuveen Global Infrastructure A fund at 10%, Macquarie Global Listed Infrastructure I fund at 9.6%, and MultiConcept Partners Group Listen Investments Sicav Listed Infrastructure P fund at 8.5%.

While the funds produced decent returns for three years, the best performing fund over one year was the Franklin fund at 0.8%, suggesting infrastructure funds need a longer investment horizon.

Magee said for public listed infrastructure he would typically look for an investment time horizon between one to three years, and over 10 years for the private direct infrastructure side.

“The projects take a long time, they tend to be quite large and I do think that the institutional appetite on private direct infrastructure is due to the long duration cashflows that match pension liabilities so I think it’s an attractive asset class for long-term institutional investors,” he said.

The First State fund invests the most in electric utilities (23.5%), highways and rail tracks (17.1%), oil and gas storage and transportation (15.1%), multi-utilities (12.5%), and railroads (9.1%).

It has its largest country weighting towards the US (52.5%), Canada (12.4%), Japan (7.3%), UK (6.7%), and Australia (5.9%).

The Franklin fund has its highest sector weighting towards oil and gas storage and transportation (20.5%), multi-utilities (17.4%), airport services (15.6%), electric utilities (14.9%), and highway and rail tracks (13%).

It also had its highest country weighting towards the US (37.7%), followed by Canada (11.1%), Italy (9.6%), France (6.9%), and Australia (6.7%).

The top funds were found through FE Analytics within both the FCA Recognised and Offshore Mutual universes that were either domiciled in Luxembourg or Ireland.

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