Infrastructure is ‘not just a bond proxy’

There is a common belief among the investment community that infrastructure and other real assets are little more than a “bond proxy”. Speaking at The Inside Network’s Equities Symposium in Adelaide recently, Jonathan Reyes, portfolio manager of the Ausbil Global Essential Infrastructure Fund, explained why this is a misperception.

The simplest explanation, of course, comes from history. It is now abundantly clear that the end of zero-interest-rate policy is here, with most major central banks around the world having already begun the challenge of raising rates for the first time in many years.

In just a few short months, the devastation has been widespread, with unprofitable tech companies selling-off first, than long-duration government bonds and now even profitable technology companies. One sector has stood out amid the volatility, however, and that is utilities. This isn’t a surprise, says Reyes, and the reason is simple: this has happened nearly every other time rates have been increased.

In 2004, the US Federal Reserve commenced what would become 17 consecutive rate hikes, with a similar series occurring in 2015 as the global economy emerged from the GFC. Naturally, you would expect assets like infrastructure to fall in value during these periods, but the opposite actually occurred. The reason for this is because infrastructure, or more specifically, assets that are essential to our daily lives, benefited from a general uplift in the economy.

Both the 2004, 2015 and today’s hiking cycle occurred with the backdrop of otherwise strong economic growth, Reyes explained. Unemployment has fallen in 2022 just like previous cycles, and the economy is returning to its previously strong position.

There are two unique transmission mechanisms within infrastructure that have driven such strong performance, he says. The first is the inherent inflation protection, in that the income streams from regulated assets like toll roads, airports and grids, are automatically indexed and increased against inflation on a quarterly basis.

So, at the very worst, an infrastructure asset keeps up with inflation. Reyes says this is why 96 per cent of the Ausbil portfolio is “directly able to capture every movement in inflation.” The second mechanism may well be the most important, and that is the ability to capture higher revenue levels via higher throughput in these key assets,which naturally occurs when an economy is growing strongly.

In the case of Australia, Transurban is the perfect example. According to Reyes, the group has been able to grow revenue at twice the rate of inflation for a number of reasons. One is simply the continued growth and widening of the City Link toll road in Melbourne, and the other is a change in vehicle mix that is associated with greater economic activity and consumer spending; for example, more trucks moving more goods equals more revenue. 

This is the key reason why Reyes views infrastructure assets as an “asymmetric” or “levered play on inflation,” because you not only get an inflation hedge, but the benefit of higher activity feeds-through to the bottom line. It is this effect that has resulted in the sector delivering returns of 67 and 88 per cent in previous hiking cycles and why Reyes believes this cycle is “rhyming with previous ones.”

Another less appreciated aspect of inflation he raised was the fact that of all the key secular trends occurring in the global economy, be it e-commerce, decarbonisation or electrification, “infrastructure lies at the centre.” Without investments in infrastructure none of these advancements are possible, suggesting a continued flow of capital and returns to investors over the long term. There is little wonder then, that sovereign and industry funds are “willing to pay above listed market valuations” for monopolistic assets.  

Staff Writer