Jim Wright, Fund manager for the Premier Miton Global Infrastructure Income Fund highlights why he believes the long-term qualities of the listed infrastructure asset class remain compelling.
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
A constructive appeal
Listed infrastructure, alongside other sectors invested in real assets, has had a tough year. The sector has been hit by negative sentiment as interest rates have risen, and its relative attractiveness as a source of income has been undermined by higher rates of income on cash and on investment-grade bonds. However, we believe that the fundamental qualities of many listed infrastructure companies and assets are misunderstood by the equity market, and the future growth prospects of these companies and assets are underestimated. With many stocks now available at significantly cheaper prices than twelve months ago, we see a great opportunity for long-term investors to tap into resilient and growing earnings and dividend streams, at constructive valuations.
So, what are these qualities, and why is the equity market underestimating the future growth prospects of listed infrastructure assets? Perhaps the most important, and the aspect of infrastructure most misunderstood or neglected by investors, is the underlying inflation linkage embedded across much of the asset class. This is manifested both in regulated assets, where regulators often give asset owners the ability to raise prices in line with local inflation rates, and to pass through the increased cost of their debt to customers, and in assets with long-term contracts where the counterparty pays a fixed amount for capacity with an annual escalator, which again is often linked to the underlying rate of inflation.
The time-lag effect
There is an important nuance which we believe can obscure this inflation linkage, which is time-lag. As the costs for the owner and operator of an infrastructure asset are rising in real time, they will impact the profit and loss account immediately. Conversely, the regulated settlement or the contract escalator will capture the inflation rate at a fixed point, or over a preceding period of measurement, and apply this to future revenues. Therefore, at a time when the rate of inflation is rising quickly, there is a short-term adverse impact on profits, as costs rise before revenues catch-up.
This is what we observed through 2022 and the first quarter of 2023. As revenue rises based on a period of rising inflation continue to feed through to earnings, this may provide a positive tailwind for the sector through the remainder of 2023 and into 2024.
Harnessing the power of the energy transition
Another facet of infrastructure which has largely been ignored by equity markets, in the recent sell-off, is the exposure that the sector offers to the very significant long-term trends in society, and the growth that it can derive from these trends. Front and centre here is the energy transition, and the decarbonisation of the global economy in response to climate change. This will require huge investment in electricity transmission and distribution networks, in natural gas and liquified natural gas infrastructure and in renewable generation and energy storage.
All of these assets are widely owned across the listed infrastructure equity universe, and the returns both from existing assets and from new investment opportunities will provide a powerful growth dynamic for the sector. Other themes, such as US onshoring, the growing global middle class and the growth of high-speed data communications will also provide momentum for growth from infrastructure assets.
The final word
The inflation linkage and the exposure to visible and resilient growth drivers provide a counterpoint to the argument that investors should look to yields on cash and low-risk short-duration assets for income, rather than listed infrastructure stocks and funds.
We believe that we have good visibility around long-term growth in infrastructure returns which can underpin long-term dividend growth, even if the economy slows. This may make returns on cash and nominal bond coupons relatively less attractive over time when compared to the dividends available from listed infrastructure investments.
It is this growth potential that can set infrastructure returns apart from the fixed coupons available on cash and cash-proxy investments and may create an attractive opportunity for long-term investors.