Here at The Constant Investor we are big believers in the concept that unlisted infrastructure can be a useful part of a portfolio. There are a few reasons why infrastructure is a great choice as part of a balanced portfolio, as well as some things to be aware of when making your investment decisions.
Infrastructure can include a number of different asset types such as airports, toll roads, ports, railways, hospitals, utilities like energy and water, as well as agricultural infrastructure like irrigation. It’s an interesting asset class because not only is it essential to a well-functioning economy; it tends to be operated or managed for its investors over a predetermined length of time and is therefore predictable (to a point). It may also be more highly geared than some other asset classes: building a power station takes a bucket load of cash, but you can be fairly certain people will use it more or less according to expectations.
Infrastructure often has a tendency to be a natural monopoly or oligopoly. (An oligopoly is like a monopoly, but with a few players in the market instead of just one. It’s a monopoly with friends.) The reason why infrastructure is often oligopolistic or monopolistic is there won’t be a large number of competing airports in any given city. A toll road is unlikely to be set up in competition with a current one and there are only so many ports investors are prepared to build in the same place. When this is the case, it results in a complete or very large capture of the market with returns to match.
That’s not to say that this is an asset class without risk: far from it. Even a piece of essential public infrastructure can be mismanaged to the point of unprofitability. Government intervention into the market can be politically, not economically motivated or just plain ill-advised, rendering a piece of useful infrastructure difficult to manage profitably. Infrastructure is also still affected by the general economy: without enough users or demand any piece of infrastructure may not be profitable.
In this sense, infrastructure is no different to any other investment. It has its risks and rewards and as always the answer to every question one might ask is: “it depends”. In this part of the project we’ll be examining ways to invest in unlisted infrastructure. Here we’ll talk about its advantages as well as some of the things you need to be aware of. As a general introduction, this guide by ASIC <https://www.moneysmart.gov.au/media/340324/investing-in-infrastructure.pdf> is a good start to considering infrastructure.
As always, this isn’t financial advice, it’s an analysis of this part of the investment market. These investments may or may not be a suitable addition to your portfolio, but it’s a useful place to begin your own research.
Advantages of Unlisted Infrastructure
Unlisted infrastructure offers a few advantages to a portfolio. It can offer another means of diversification, the long-dated nature of the assets can mean there is a stability to the return generated by them, not being listed means it can have lower volatility. Lastly, unlisted infrastructure can be uncorrelated or have a low correlation with other, listed investments. We’ll go through each of these advantages in turn.
Unlisted infrastructure can diversify your portfolio.
Most people own property, they hold cash and many hold some equities. Hardly any of us own a toll road, airport or a suite of irrigation licenses. Infrastructure is a basic diversification play.
Infrastructure tends to be long-dated.
Ports, toll roads, airports are all amenities built to be used for decades. This means that these assets act a little like bonds: there is a fairly consistent (though variable) yield that lasts for a pre-determined length of time. It also means that it can be viewed by some investors as a bond-substitute and that it may currently be overpriced. This may be true for listed and unlisted infrastructure alike.
Unlisted infrastructure is valued on a less regular basis than listed investments and not only by the market.
This may mean that unlisted infrastructure is less subject to those “animal spirits” discussed by the famous economist Keynes. Listed infrastructure may be over- or under-valued by the market when compared to its net asset value. The upshot is that over the same period of time, unlisted infrastructure pricing tends to be less volatile than the listed kind.
Returns on unlisted infrastructure may not be correlated with returns of some other investments.
For all the reasons discussed above, unlisted infrastructure is an asset that behaves differently to, say, equities on the ASX. This can be advantageous from a diversification point of view: when the market is having a conniption because of something Janet Yellen did or didn’t do, it’s useful to have a part of your portfolio that will ignore that fact and continue on as before.
That said, this shouldn’t be taken to mean that there aren’t events that can’t affect unlisted infrastructure and listed assets in tandem. A severe economic turndown may reduce airport profitability whether that airport is listed or unlisted. New government regulations may affect listed irrigation funds and the unlisted kind alike.
Ordinary macroeconomic factors like inflation, productivity and GDP growth may affect all investments: but in differing ways. This is the key point: unlisted infrastructure isn’t divorced from the economy. It just reacts differently.
Things to Think About When Investing in Unlisted Infrastructure
I’ve outlined a few reasons why I think unlisted infrastructure is worth exploring in your portfolio. There are a few things worth being aware of and researching while you’re making your decisions.
Unlisted infrastructure is a great diversification play- but is it doing what you want it to in your portfolio? How much do you need to invest and will that weight your portfolio towards one asset or sector more than you are comfortable with? How does this fit in with your listed assets? Do you hold similar sectors in listed form? Is the fund or investment concentrating on one sector or industry? Or is it a mixed bag of infrastructure? How does that affect your diversification strategy?
What is the maturity profile of the assets held by the fund you’re looking at?
Does this fund have an array of assets that will keep generating returns for years to come? What is the fund’s “pipeline”? You will be able to find out what returns over recent years have been like, where does the manager expect returns will eventuate over the next few years?
What is the risk profile of this fund?
Where are the sector risks? Where are the macroeconomic risks? Where are the market risks? Do these meet with your expectations?
What’s your investment horizon?
These tend to be long-dated assets. Are you investing for two, ten or twenty years? Make sure the fund’s stated outcomes and strategy matches yours.
What’s the fine print on liquidity?
Many of these funds are not a liquid investment. That’s not necessarily a bad thing, but it’s something to be aware of. What are your liquidity needs in the next several years? What will happen if you can’t access the funds you have invested? Are you comfortable with the provisions in place? This is an excellent point to pick up the phone and talk directly with the fund you’re interested in. A good fund will talk you through the fine print.
Are you paying a premium?
As a bond substitute, infrastructure is riding an impressive rate of return. Do you feel comfortable with the evaluation of the fund? If there is a short term re-evaluation of the fund’s assets, how does that effect you? If infrastructure begins to return lower yields as the bond bubble unwinds, how does that affect your investment decisions?
What’s the management of the fund like?
Even the best piece of infrastructure can be unprofitable and mismanaged. Do you feel that the fund managers have a pretty good view of the assets they’re investing in? Do you feel they are qualified, experienced and know what they’re doing? This is another good point to pick up the phone. Ask all the questions, see what they come up with.
How much development risk is the fund exposed to?
How much of the fund’s projected returns depend on projects in development? There has been a noted infrastructure boom and building infrastructure involves risks: do you feel the fund has paid a sensible price for its assets? Do you feel that the fund’s pipeline is adequately diversified for development risk as well as others?
What’s the fund’s benchmark and objective?
Past returns may be no indicator of future returns: but a benchmark and objective give you a pretty good idea of what the fund is trying to achieve. Usually this is expressed something similar to “Aims to exceed [insert benchmark here] by X% over Y years.” Go and have a look at the benchmark (Google the name and usually you’ll be able to find a chart), does that rate of return look acceptable to your needs? Does the timeframe posed by the fund match yours?
What are the current and recent rates of return?
Are the current and recent rates of return higher or lower than that objective? Why do you think this is? Does that meet with your expectations? Do you think returns will continue at that level in the medium term? What if they don’t? How would that affect your investment decision?
These are just a few questions to start your research for any infrastructure fund you might be interested in. As always: don’t hesitate to pick up the phone and ask them or any others that may come to mind.
Who Did We Research and Why?
We’ve tried to provide a number of differing options to explore in this project. Rather than considering this a list of things to invest in, think of this as a starting point of what’s possible for the smaller, non-institutional investor. We’ll be looking at both classic mixed infrastructure funds and funds that concentrate on specific areas of infrastructure. To start us off, we’ll be looking at the Blue Sky Water Fund and the Investment Partners Infrastructure Fund.