With government bond yields at record lows and in many cases delivering negative real yields (after inflation), investors have had to look to additional asset classes to meet their income needs. A popular income solution for many is global listed infrastructure.
The asset class has a long-term record of consistently delivering attractive yields and offers a growing income stream linked to the asset base of the companies rather than the business cycle. It also provides portfolio diversification benefits, such as a lower correlation (relationship) to equities.
By investing in infrastructure, one invests in the companies that own and operate the physical assets that provide many essential services to society. These are services we use and interact with every single day. For instance, we use gas, water, and electricity to carry out our daily activities.
We also use transportation infrastructure, such as rail and roads, to get around and communication infrastructure, such as cellular towers, to connect with each other.
Broadly, infrastructure can be categorised into two key buckets:
With regulated assets, such as water, electricity and gas transmission and distribution, the regulator determines the revenues that a company should earn on their assets. If an asset earns too much, the company is required to return some of its revenues to its customers by lowering prices.
Conversely, if the asset earns too little, the company is allowed to increase its prices. Because demand for these assets is steady and the regulator determines revenue, companies owning and operating regulated assets show a relatively stable cash flow profile over time.
Additionally, the regulator periodically accounts for inflation and bond yields, which means price increases are often linked to inflation, and long-term valuations are relatively immune to changes in bond yields.
With user-pays assets, pricing is generally set by contracts, where volume and revenue is determined by how many people use the assets. User-pays assets are usually physical assets, such as rail, airports, roads and telecommunications towers, which move people, goods and services throughout an economy.
As an economy grows, develops and prospers, demand for these assets also typically grows. For instance, as more people use, and to some degree, depend on mobile phone data, we see mobile communications operators adding additional capacity to the physical towers to meet this demand.
Infrastructure companies can, therefore, potentially provide predictable income distributions due to stable earnings derived from underlying assets. For investors, this can offer better visibility for revenues and dividends.
Chart 1 below illustrates that global infrastructure has delivered to investors a higher yield than global equities and global bonds - and, over most time frames, a yield greater than global listed property.
Source: ClearBridge Investments * As at 30 June 2021. *Global Listed Infrastructure: ClearBridge Investments Income Universe, monthly since June 2010. Global Equities: MSCI World Forward Dividend Yield, MXWO Bloomberg, Global REITS: FTSE EPRA/NAREIT Forward Dividend Yield - FENHG Index, Bloomberg, US Benchmark Bond 10 year – Yield, Factset Research Systems, United Kingdom Benchmark Bond 10 Year - Yield, Factset Research Systems. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situations or needs of investors. Past performance is not indicative of future performance.
In this current environment, investors have had to look beyond traditional sources of income. Although global equities and Australian Real Estate Investment Trusts (A-REITs) can provide attractive yields relative to bonds, both have revenues and, ultimately, dividends closely linked to economic activity.
In ClearBridge’s view, infrastructure has an edge as a long-term income solution, as revenues are generally linked to the asset base of infrastructure companies.
As a result, it is necessary to understand the quality of an infrastructure company’s assets and a detailed assessment of the regulation or contracts governing them. This is what delivers stable cash flows and greater capital stability.
As demonstrated in Chart 2 below, dividend growth for infrastructure companies has closely tracked the growth in the asset base of infrastructure companies.
Chart 2: Infrastructure dividends linked to a growing asset base
Source: ClearBridge calculations as at 30 June 2021. ClearBridge Infrastructure Income Strategy. Past performance is not indicative of future performance.
Many investors believe that they already have exposure to infrastructure as a part of their traditional global equity portfolio. Although this is true to an extent, a global equities portfolio will generally only provide a small exposure to a handful of large-cap utility companies.
A dedicated listed infrastructure allocation provides not only reliable and growing income, but also diversification across infrastructure sub-industries as well as political and regulatory regimes, where risks differ. It also offers the ability to invest across the market cap spectrum where specialist sector knowledge can be applied.
In addition to attractive income, infrastructure can also strengthen overall portfolio outcomes.
To illustrate this point, below is an efficient frontier created by different combinations of global equity and global fixed income since January 2010, with a traditional 60% equities and 40% bonds mix, marked with the blue diamond in Chart 3.
Chart 3: Efficient Frontier