Tigran Manukyan & Daniel Ryan, Fidelity Multi Asset Alternatives Analysts
Infrastructure has received plenty of attention from investors in recent years owing to its diversification benefits, as well as attractive returns and yields. In a world of volatile equities and steepening yield curves, alternatives analysts, Tigran Manukyan and Daniel Ryan explore the role of infrastructure as part of wider multi asset portfolios and answer four key questions investors ask when it comes to considering an allocation.
1. What are the different types of infrastructure classifications?
We group infrastructure investing into two main types. The first category is known as core infrastructure. This includes often highly regulated assets that are not subject to changes in demand, have predictable government-backed revenue streams and a monopolistic hold on their industry. Investments in network assets like the electricity grid, water systems, transport links and telecoms networks are some good examples.
The second type is known as non-core (or core+) infrastructure. This represents a broader space, encompassing many types of assets with differing cash flow profiles. It can also include assets that have more market and demand risk than core infrastructure, that offer greater variability in profit margins for investors. Investments in car parks, toll roads and renewable energy assets such as wind turbines and solar panels often fall under this umbrella. This category may also comprise of core assets in emerging market countries that have shorter track records of providing such services and of following regulations.
2. What role can infrastructure play as part of an overall portfolio?
Infrastructure assets have several key benefits. Firstly, many core infrastructure assets can deliver stable, predictable government-backed income streams with returns that have a low correlation with traditional asset classes. They can therefore offer a good yield, a key benefit for income-focused investors. Supporting this, the risks of infrastructure tend to be less sensitive to GDP given their inelastic demand characteristics. As such, some core infrastructure assets may benefit from a lower risk profile since many are concessionary, meaning that the income can be linked to hours of usage time and not demand. Such assets are described as availability based, meaning the government pays for the asset, no matter who uses it, guaranteeing the steady income stream.
At the same time, some non-core infrastructure assets such as toll roads can be demand-based (where the road is paid per car used and not for just being open), and this can produce higher returns particularly when traffic is higher than expected. This highlights the broad-based and heterogenous nature of the asset class - especially when we consider differing risk appetites - that may suit many different types of portfolios.
Environmental, social and governance (ESG) considerations are also an important factor. Investing in infrastructure can be of greater social and environmental good than other asset classes. For example, participating in the Thames Tideway project which aims to stop sewage dumping into the Thames, or wind and solar farms doing a lot for improving how sustainably we use the world’s resources.
At a time when inflation is a concern to many investors it’s worth noting that many infrastructure assets also offer the additional benefit of providing a hedge against inflation. Many infrastructure assets offer cashflows explicitly linked to inflation through regulation, concession agreements or government contracts. Infrastructure assets without explicit inflation links could also often utilise their pricing power to pass price changes onto customers to the benefit of shareholders, due to their strategic position and lack of competition. Infrastructure assets may also benefit from soft inflation linkage through owning the real assets themselves, as the values of these assets are typically positively correlated with inflation.