The recently launched IA Infrastructure sector is a fertile hunting ground for UK fund selectors looking to compare infrastructure funds of various shapes and sizes. The exact definition of infrastructure investing is often debated, with the IA’s own – non-exhaustive – definition covering “companies involved in the ownership, operation or maintenance of infrastructure assets, (including but not limited to utilities, energy, transport, health, education, security and communications)”.
Infrastructure businesses across toll roads, railways, telecommunication companies and energy pipelines often benefit from inflation-linked return streams. Other stocks, too, offer impressive defensive properties – the clearest examples being utility companies that provide key services to households and businesses across water, gas and electricity.
Specialist infrastructure funds can be an attractive diversification option as they deliver a differentiated return stream to that of both equities and fixed income over the longer term. As such, they can be an appropriate holding within either an alternative or global allocation in investor portfolios.
With regard to the returns on offer from infrastructure companies and funds, we would highlight the high and growing income stream they can deliver, noting the potential for income to grow in real terms over time can help protect investors from inflation. Well-run infrastructure funds also offer investors the potential for capital growth over time through good stock selection.
Macroeconomic backdrop
Infrastructure managers expect many structural thematic shifts will support their sector over the years ahead, including decarbonisation, the 5G roll-out and the valuation opportunity of listed versus unlisted infrastructure assets – to name just a few.
With respect to nearer-term factors, and with interest rates rising across developed markets, some managers are actively tilting their funds to defensive businesses that can perform in a recessionary environment – for example, water, waste and other utilities. Other managers, however, are unperturbed in their positive outlook for their companies. They maintain the view that asset-base growth should continue, which, alongside inflation-linked cashflows, could lead to strong share-price growth.
As for the current global energy situation, there is a growing consensus that global investment in renewables will increase significantly over coming years, especially after 2022’s rising energy prices driven by the war in Ukraine. Most managers believe listed utility companies will be some of the key drivers – and beneficiaries – of this energy transition.
Tied to this, many managers are keeping a structurally high exposure to US utility companies they expect can obtain significant earnings upgrades after the passing into law last summer of the Inflation Reduction Act. These businesses will be competing for US government funding based on both their energy transition and customer pricing plans.
Measuring performance
During the first nine months of 2022, the infrastructure sector provided a rare bright spot for investors. This was due to its defensive characteristics and, often, inflation-adjusted pricing arrangements that enable companies to pass rising costs on to end-consumers. The Inflation Reduction Act offered a further boost in the middle of the year.
For 2022 as a whole, against the backdrop of high inflation and rising interest rates, a mainstream infrastructure index had climbed 17.9% (in GBP terms) to 12 September, far outperforming the 1.5% loss of the MSCI World Index. The relatively long-duration nature of the sector subsequently caught up with it, however, as interest rates rose further in the final months of the year. Nonetheless, the index ended the year up a still-impressive 7.2%, versus the MSCI World’s 7.8% loss.
The strongest-performing sub-sectors of 2022 were energy midstream companies, such as natural gas and oil pipelines, and liquefied natural gas terminals, which were supported by higher energy prices through the year. This provided a performance headwind to sustainably managed funds, which naturally tend to shun the pipelines sector.
The transportation sector, which includes airports and toll roads, was another stronger performer as the global economy continued to recover from the Covid lockdowns – causing further headwinds for sustainably managed funds, which again tend to be underweight these sectors. Poorer-performing infrastructure sectors last year were those that tend to be more highly leveraged and therefore dragged down with higher discount rates, such as telecommunication towers and data centres.
Despite the strong performance relative to global equity markets, returns for 2022 still lagged behind rampant inflation in developed markets. That said, the full inflation protection benefits tend play out over a one to three-year period, as the immediate impact of higher discount rates pulls down share prices. Thereafter, headline inflation starts to kick through in company revenues in the years that follow.
FUNDS TO WATCH: 3-YEAR PERFORMANCE
1. Macquarie Global Infrastructure Securities is the oldest fund in the sector and also the strongest performer over three years. The offering benefits from the firm’s size and its involvement across the capital structure of infrastructure companies, spanning advisory services, research, debt and listed and unlisted equity. Strong performance in 2022 was driven by the managers tilting the portfolio towards inflation-linked names and energy infrastructure companies, such as Cheniere Energy, one of the world’s largest liquefied natural gas-exporting businesses.
2. VT Gravis Clean Energy is the next-best performer over three years. This newer fund – launched in 2017 – invests in renewable energy assets across wind, solar and hydrogen in the operational rather than greenfield/construction stage of development. The fund is predominantly invested in closed-ended investment companies, such as Greencoat UK Wind, rather than traditional equities. The portfolio is split across more than 1,000 different renewable energy projects, the majority of which have contracted revenue streams. The bulk of the fund’s three-year returns were delivered in 2020, due to both the resilient operational performance of assets and positive investor momentum behind the clean energy sector.
3. Another top performer over three years is M&G Global Listed Infrastructure, which is run by global equities manager Alex Araujo, and launched in 2017. The fund deploys a wider definition of ‘infrastructure’ than others, investing across critical infrastructure and perpetual royalties. These royalty companies, along with energy pipelines, utility companies and transportation, were strong performers in 2021 and 2022. Communication businesses, on the other hand, fell from the top to the bottom-performing sector over those two years due to the rising discount rates in the market.
FUNDS TO WATCH: NEWCOMERS
1. The Downing Listed Infrastructure Income Fund, managed by Josh McCathie, has been designed to provide access to the UK-listed infrastructure and renewable energy investment trust universe with the aim of delivering an attractive and sustainable yield. To be included in the fund, investment trusts mus t be focused on one or more of the following areas: digital infrastructure, social infrastructure, renewable energy, transportation and utilities.
2. The managers of EdenTree Green Infrastructure have extended the fund’s offerings in responsible and sustainable investing to encompass this green infrastructure fund, which focuses exclusively on ‘green’ projects owned and run by ‘green’ companies. The fund will therefore be absent in sectors such as toll roads and airports, instead focusing on areas such as renewable energy generation and energy storage and efficiency. The fund can also invest up to 20% in other sustainable assets such as carehomes and social housing, which provides greater portfolio diversification.
3. Distributed by Marlborough in the UK, the Marlborough Global Essential Infrastructure Fund’s management team is Australia-based and part of Ausbil, a leading Australian investment manager. The broader strategy has a four-year track record focusing on what the management team deems ‘essential infrastructure’ – in other words, businesses that are typically regulated or have a track record of stable cashflows through the economic cycle. This focus results in holdings across the following sectors: water utilities, regulated utilities, toll roads, airports, regulated pipelines and mobile towers.
FUNDS TO WATCH: ASSETS UNDER MANAGEMENT
1. The largest player in the sector is First Sentier Global Listed Infrastructure, a Square Mile AA-rated fund. The large and experienced fund management team, led by Peter Meany is based in Sydney and offers a core infrastructure approach that aims to provide defensive ballast in down-markets. We view the strategy as a good offering for investors who wish to gain exposure in the global listed infrastructure space through an investment process taking account of both quality and value factors.
2. The iShares Global Infrastructure ETF is a passive offering from iShares and is the next-largest fund in the sector. Seeking to replicate the returns of the FTSE Global Core Infrastructure Index, this fund is therefore around 50% invested in utility companies, with the remainder split across industrials, energy, real estate and telecommunication businesses. More than three-quarters of the holdings are based in North America
3. The FTF Clearbridge Global Infrastructure Income Fund is the third-largest in the sector and one of the strongest performers – and is Square Mile AA-rated. The management team is also based in Sydney although, as of September 2019, they merged with US-based Clearbridge Investments. From the team’s perspective, to be termed as ‘infrastructure’, the underlying investment must be a real asset, available for public use and have a regulatory framework behind it. Within these parameters, regulated utilities will always make up at least half of the portfolio – and often much more. We like this defensive, global listed-infrastructure fund, which is run by a strong team that looks for companies with strong asset-base growth and regulatory protection.
Paul Angell is a senior investment consultant at Square Mile Investment Consulting and Research
This article first appeared in the April edition of Portfolio Adviser Magazine
