Laying the foundations - infrastructure investing

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.

3. Are infrastructure assets risk-free?

While infrastructure offers several important diversification benefits to a multi asset portfolio, it’s important to understand the range of risks associated with the asset class. Firstly, many infrastructure assets remain vulnerable to political risks. A government could theoretically decide to requisition or nationalise infrastructure assets and though this is generally more of an issue in emerging markets, it was a consideration for us last year in the UK due to the Labour Party’s election campaign rhetoric.

Additionally, infrastructure assets are often strongly regulated and can therefore be highly sensitive to regulatory risk. Utility type assets are often most susceptible to this type of risk, with rules often being set by governments on the quality of the infrastructure that needs to be maintained, which can be very costly. Alternatively the maximum amounts can be charged to protect customers to counter monopolistic unlimited pricing power. Changes in these regulations can affect the attractiveness of an infrastructure investment opportunity.

Lastly, valuations of projects within infrastructure are based on models which discount future cash flows, inflation and interest rate movements into the present, and therefore are sensitive to small changes in long-term assumptions. If any assumptions at acquisition are wrong, valuations will change, causing investors to overvalue or undervalue the costs of projects’ cash flows greatly over a decade or two. Robust, fundamental analysis is therefore critically important - within Fidelity Multi Asset we stress test our assets’ performance across a range of market scenarios, making sure our projections have downside risk fully built in.

4. How can infrastructure complement a portfolio?

Within multi asset portfolios, infrastructure can play a strategic role as both an equity-like return and income generator. Its asymmetric qualities versus traditional asset classes may also prove particularly important, given the current economic uncertainty and volatility we’re seeing in markets today.

Nonetheless, when investing in infrastructure - as with any asset class - it is extremely important to scale positions intelligently, constructing a portfolio with risk spread across underlying investments.

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Important information

This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in small and emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document and annual and semi-annual reports, free of charge on request by calling 0800 368 1732. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority and by Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0720/31723/SSO/NA