With inflation running hot across global markets, investors are looking for a hedge against stubbornly high inflation. For those looking to achieve inflation-linked absolute returns, infrastructure provides many unique and attractive characteristics that make it a compelling option compared to other asset classes, like commodities or real estate. Given the significant risks within the current market environment, including recession fears, global political tensions, rising global rates and high inflation, we think investors can benefit from growing their allocation to infrastructure.
Infrastructure provides the essential services we use every day; it heats and cools our homes, transports people and goods across borders, and connects us through wireless towers. With its essential role in our economies, infrastructure provides investors with stable and growing cash flows, inflation protection and lower correlations with equity and debt sectors. As an added benefit of the asset class, we see long-term growth in infrastructure with the push toward decarbonization of the global economy.
Why infrastructure is a robust inflation hedge
Infrastructure has two main features that make it a robust inflation hedge, the first being its unique pricing mechanism.
In the case of regulated assets, including water, electricity and gas transmission and distribution, rising inflation will have little impact on valuations as inflation can be directly or indirectly passed through to customers. While regulations in different countries have various technical differences, in essence, regulation is designed to protect the return utilities receive for capital investment against macroeconomic changes, which include inflation.
Other infrastructure, like communications, typically have long-term contracts built within their pricing mechanism that include price escalation to account for changes in inflation.
Assets with concessions, contracts, tariffs, and tolls, also known as user-pay assets, also pass-through inflation because the control of prices is set in a contract agreed upon at the time of grant of the concession, with volume risk (such as traffic, passenger, and container) borne by the operator. Because of these features, heightened inflation has limited impact on infrastructure asset valuations.
The second feature that makes infrastructure a good inflation hedge is its monopolistic market structure. As mentioned above, infrastructure assets deliver essential services to society and often do not compete with other entities in providing these kinds of services. Water or energy utility companies, for example, are typically the only providers for a given region, which ensures that these companies will continue to have robust demand regardless of what is happening in global markets.
Within the asset class, we see an advantage in listed infrastructure assets over unlisted assets.
Over the past two decades, we have seen mainstream adoption of both listed and private market infrastructure strategies. But before investors look to expand their holdings in infrastructure, we believe it is important to distinguish between two types of assets: listed and unlisted infrastructure. Listed infrastructure assets are securities issued by publicly traded, liquid, core infrastructure companies, often in regulated utilities and user-pays assets. Unlisted infrastructure assets, on the other hand, are owned by investors directly and not through a public exchange. Some assets, like schools, universities, hospitals and government facilities, are available only through the unlisted market. Over the past decade, unlisted infrastructure has benefited from the growth in allocations to alternatives.
While investors can enhance outcomes by investing in both listed and unlisted infrastructure, listed infrastructure offers access to a greater overall investment universe with a broad, deep, geographically diverse and liquid range of opportunities. In fact, we estimate that the universe of listed infrastructure assets is more than three times larger than the unlisted universe. Further, there are 2x more infrastructure assets in listed structures than unlisted structures in Europe, 4.5x more in North America and 10x in developed Asia Pacific markets, such as Australia, Japan and Hong Kong.
With listed infrastructure assets that are publicly traded, it’s easier for the average investor to access information and disclosures on company sustainability, capital structure and performance. Additionally, listed infrastructure also provides investors with the flexibility to choose or amend their investment horizon, liquidity preferences, sensitivity to short-term price volatility and choice of underlying asset risk exposure. The ultimate decision on the split between the two should be optimized for investor preferences such as liquidity, choice of underlying asset risk exposure, sensitivity to short-term price volatility and the opportunistic use of market mispricing and arbitrage.
There is a significant amount of capital waiting to be invested within the infrastructure space.
While allocations have increased to private market transactions and unlisted infrastructure, the increased demand has not been met by an equivalent increase in the supply of suitable investment opportunities. We see private infrastructure capital continuing to come to listed markets and finding attractively priced assets for acquisition. Currently, with over US$300 to $400 billion of capital waiting to be invested according to Preqin, companies in the listed infrastructure universe will benefit as listed players look to sell assets, often non-core or minority interests, for well in excess of their fair value. On average, our investment team has seen these sales done at roughly a 30% premium to where they are currently trading or their implicit value within these companies
The global move towards decarbonization is also providing a significant tailwind for infrastructure.
We see significant long-term advantages for infrastructure with the global push toward net-zero carbon emissions and decarbonization. There is no asset class more at the forefront of delivering on this policy goal. This movement is accelerating the shutdown of carbon-emitting power generation assets (namely coal and gas) in favor of wind, solar and hydrogen assets, which are just a few of the growing investment opportunities within the infrastructure asset class. The listed investment universe provides exposure to the largest renewable energy companies in the world, including Iberdrola (Spain), Clearway Energy (U.S.), NextEra Energy (U.S.) and SSE (U.K), to name a few. The liquidity provided in the listed infrastructure space allows asset allocators to be more flexible in rotating their funds based on how the structural outlook for renewable energy assets evolves over the decades ahead.
Given the current market environment, we believe there will be a rough road ahead for most equity sectors. Over the past quarter, infrastructure and utilities continued to perform well amid heightened volatility for equities in general, as their stable cash flows, growing dividends, essential service nature and ability to pass through inflation offered a hedge . Investors can access the generational theme of decarbonization through infrastructure, including renewables, global regulated utilities and even midstream pipelines that can facilitate the energy transition through hydrogen or carbon capture and storage. This will drive significant opportunities for many listed companies.
In short, the current market environment is an opportunity for infrastructure to shine.
Charles Hamieh is a Managing Director and Portfolio Manager for ClearBridge Investment’s Global Infrastructure Strategies.
About ClearBridge Investments
With $157.4 billion in assets under management (AUM) as of June 30, 2022, ClearBridge Investments is a leading global equity manager committed to delivering long-term results through authentic active management, offering investment solutions that emphasize differentiated, bottom-up stock selection to move clients forward. The firm integrates ESG considerations into its fundamental, bottom up research and stock selection process across all strategies. Owned by Franklin Templeton, ClearBridge operates with investment independence from headquarters in New York and offices in Baltimore, London, San Francisco, Sydney and Wilmington.
ClearBridge focuses on three primary client objectives in its areas of proven expertise: high active share, income solutions and low volatility. Its strategies are available in separately managed accounts, mutual funds, collective investment funds as well as custom solutions, commingled vehicles and offshore funds. See more here.
Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional.
All investments involve risks, including possible loss of principal. . Companies in the infrastructure industry may be subject to a variety of factors that could adversely affect their business or operations, including high interest costs in connection with capital construction programs, high degrees of leverage, costs associated with governmental, environmental and other regulations, the effects of economic slowdowns, increased competition from other providers of services, uncertainties concerning costs, the level of government spending on infrastructure projects, and other factors. An investment in any alternatives or private placements could involve a high degree of risk and is suitable only for investors who can afford to risk the loss of all or substantially all of such investment. Strategies may hold illiquid investments and its performance may be volatile. There can be no assurance that any strategy will be adequately compensated for risks taken. A loss of an investor’s entire investment is possible. The timing of profit realization, if any, is highly uncertain.
© 2022 Franklin Distributors, LLC (“FD, LLC”), Member FINRA, SIPC. FD, LLC and ClearBridge Investments, LLC are Franklin Templeton affiliated companies.
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