Equal Opportunities
Listed assets level the playing field when it comes to infrastructure investing

Edward Keating, vice-president, Lazard Asset Management

The equity financing of infrastructure assets is returning to private capital markets after a pause of over half a century. Infrastructure equity is a separate and distinct asset class that is growing rapidly due to an increasing shortfall of public investment in infrastructure. Its management requires specialist knowledge, but it offers attractive liability-matching characteristics for long-term investors.

In the past, many investors have had suboptimal allocations to infrastructure due to high costs of access and difficulties in diversifying exposures. The global listed infrastructure markets are now of a size similar to the Australian Stock Exchange and are expected to grow much more rapidly. This offers the potential to invest in infrastructure at lower costs with greater liquidity and within a well-diversified portfolio spread across geographies, assets, regulatory regimes, and political risks.

While the infrastructure sector is relatively immature globally (Australia’s, for example, is more advanced than those of many other regions), already some leading international pension funds allocate up to 10% of their portfolio to the asset class. Early adopters of this strategy are likely to harvest returns that are well above what will be available when it becomes better understood and moves to pricing equilibrium, but care has to be taken to identify preferred infrastructure assets, rather than focusing on only the physical characteristics of the assets.

Infrastructure assets can have attractive investment characteristics, including long life, lower risk of capital loss, and inflation-linked returns. When considering an allocation to infrastructure, investors should keep in mind that achieving the desired investment outcomes requires diligent selection of investments and that the ability to recognize, analyze and diligently select appropriate investments is a critical element of infrastructure investing.

Global exchanges
The private infrastructure market is growing rapidly, and increasingly these assets are now being listed on global stock exchanges. We estimate, based on the conventional definition of infrastructure, that there are approximately 230 listed infrastructure stocks of reasonable size in Organisation for Economic Co-operation and Development (OECD) markets, with a total market capitalization of around US$2.7 trillion. Defining infrastructure is critical as not all infrastructure assets have the investment characteristics of a long-term, low-risk and inflation-hedged investment. Infrastructure can be defined as emphasizing the primacy of investment characteristics over physical characteristics. This narrower definition of preferred infrastructure assets includes three major criteria: revenue certainty, profitability and longevity.

A fund invested in listed infrastructure assets will appear more equity-like in its characteristics, but a large portion of the portfolio diversification benefit will remain. In addition, any equity market volatility will not, of course, change the underlying investment characteristics of the assets. Thus, any observed volatility will be largely equity-market noise and generally short-term in nature only. Regardless of the short-term volatility of listed infrastructure investments, distributions from these assets exhibit low volatility, high predictability, and real growth (CPI+), thereby matching the long-term liability profile of the pension fund. Listed infrastructure also has the same advantage of easy access that any listed asset has over its unlisted or direct comparative.

The divisibility that comes with listed assets provides the critical advantage of allowing investors to diversify their holdings. Rather than being committed for many years to individual infrastructure projects, investors can diversify their holdings by physical asset class, regulatory regime, currency exposure, and political risk.

Finally, for all but the largest of pension funds, direct investment has highly prohibitive costs. Direct investors must maintain a dedicated team of investment professionals, which must be further complemented with due diligence and investment banking fees at times of asset acquisitions. Via the listed market, investors are subject to the usual impacts of specialist fund managers’ fees that, although they are currently higher than many other asset classes, are significantly lower than those of the direct route for all but the very largest institutional investors.

Investors, both institutions and individuals, have long sought diversification in their investment portfolios. Infrastructure now joins the traditional asset classes of equities, bonds, cash, and property as an asset that can be used to achieve diversification.

To view the presentation, click here.