Investors split on infrastructure’s safe haven status

Asset class has long-term potential amid government-backed green initiatives but valuations are looking stretched

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A recent report from Natixis suggests that the Covid-19 crisis has further driven so-called ‘mega-trends’, particularly infrastructure with energy transition and access to high-quality digital key themes.

As the report points out, the infrastructure sector has been extremely resilient during the current Covid-19 pandemic. And while it has been affected by the crisis – just like all sectors – as a whole, it has held up extremely well over the year.

Colm O’Connor, senior portfolio manager, global sustainable infrastructure strategy at KBI Global Investors is inclined to support the positive Natixis stance.

“A small niche of investment firms identified these mega-trends 10, 20 or more years ago. The concept of renewables made sense, but they were nascent technologies, dependent on subsidies, uneconomic versus fossils.

“Similarly, we’ve spoken about video conferencing for years, it’s been at our disposal for a long-time. However, it can be difficult to transition to new practices and certainly Covid-19 has accelerated this.”

He adds: “Digital and decarbonisation are the forefront of infrastructure spend and today offer very attractive opportunities for investors.”

Mega trends

Margarita Shevtsova, senior portfolio manager equity at Actiam, agrees that the sustainable mega trends are definitely in place and while some were evident before Covid-19, some emerged only recently.

“The drastic fall in clean energy costs (both solar and wind), increase in carbon pricing, the rapid progress of clean technologies and low interest rates environment were definitely the factors that were supporting the energy transition before 2020,” she says.

However, she suggests the acceleration of public opinion and governmental focus shift was spurred by the Covid-19 pandemic. “The reduced mobility, lockdowns and almost stand-still traffic led to a substantial drop in carbon emissions.

“This has clearly showed what results can be accomplished if we switch to clean energy, especially in the transportation sector.”

By reducing freedom of movement, Shevtsova adds, Covid-19 has also forced a tectonic shift to the digital space. Most of day-to day activities, from shopping and working from home to online education and entertainment became digitalised.

Billions of dollars will be needed to create sustainable cities

Infrastructure has certainly raised a lot of funds in recent months but is it more than just a safe haven for investors during a volatile period?

Guy Lodewyckx, head of private markets multi-management at Amundi, does not believe the recent inflows have been driven by the behaviour of the asset class during the crisis.

“Of course, infrastructure is showing good resilience, but it is not really a surprise. I rather believe these flows are linked to their fundamental characteristics: low volatility, low correlation with other asset classes, protection against inflation, and also the potential environmental and social impact.”

Arnaud du Plessis, manager of the CPR Invest – Future Cities fund, sees long-term potential for infrastructure investors – not just short-term safety.

“Infrastructure is intimately related to urbanisation, which is undeniably a megatrend that was well underway before the Covid crisis and will continue to expand in the coming decades, especially in emerging markets.”

He adds: “Billions of dollars will be needed each year in infrastructure investments to meet the challenges of sustainable cities. Urban infrastructure, which is the cornerstone of economic development and energy transition, is therefore supported by a long-term growth potential.”

Pockets of infrastructure on excessive valuations

O’Connor sees things slightly differently to both Lodewyckx and du Plessis.

“Investors approach infrastructure in different ways. On the one hand, we see investors allocating to the asset class from a safe-haven perspective or liability matching, as a replacement for fixed income assets which have become less attractive against a low interest rate environment.

“This has seen some pockets of infrastructure become excessively valued. So, whilst the investor achieves perceived safe-haven status, the potential for multiple contraction will at some point loom (albeit unlikely in the near term with interest rates likely to remain low).”

He adds: “On the other hand, investors allocate to the asset class within their ‘growth’ portfolio and this is where we believe it sits. The distribution of a predictive revenue stream is attractive, but there is an ability for investors to participate in growing segments of infrastructure too, bringing with it the potential for capital gains.”

An example of the first approach might be a highly regulated utility in the US or a toll road operator in Europe.

The potential for near-term growth isn’t really there – how many new toll roads are being constructed in developed cities?

Similarly, highly regulated entities are typically constrained from significant growth but do provide inflation linkage to their income distributions.

With the latter approach, O’Connor points to the roll out of data storage, 5G, smart grids, renewable infrastructure, EV charging infrastructure, as examples that break the perception the asset class is a stagnant drip of revenue stream over multiple years.

“Capital is being deployed in these areas and investors have the ability to participate,” he says.

‘There is a risk of potential disappointment’

Shevtsova believes the environment has been supportive of infrastructure investment but warns that that it may not be a consistently smooth ride for investors over the next year.

“One of the key areas of governmental support to tackle recessions has traditionally been an infrastructure spend,” Shevtsova says.

“The year 2020 was not an exception. What was different this time, is the sustainability angle. The European Green Recovery plan and Biden’s Green Bill are examples of paths to overcome the Covid-19 crisis, create jobs and at the same time take care of the sustainable infrastructure developments and transition to green energy.”

This, she explains, is the reason infrastructure funds and individual stocks, especially with strong sustainability angle exposure, received a substantial boost in sentiment and share price performance since the summer.

The logical question, according to Shevtsova, is if there is still an upside potential given the stretched valuations and premia, as well as the fact that it will take time for the governmental initiatives to transfer into the actual orders?

She believes the upside may continue due to the structural trends and an extremely low interest rates environment, although the road can be a bit bumpy on the way.

“The valuations are stretched and the expectations for the stocks are high. Therefore, there is a risk of potential disappointment,” Shevtsova warns.

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