27 Feb 2024
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What is infrastructure?
Infrastructure refers to an asset that provides an essential service for an economy to function. Infrastructure assets provide the services that we use every day, such as our water, electricity, and gas as well as transport. There are two broad types of infrastructure assets: regulated assets and user-pays assets.
Regulated assets have revenues that are controlled by a regulator. The regulator will often target a stable return over time, while considering factors such as the operator of the asset, the economic environment and inflation. These assets are adversely impacted by rising interest rates, and slower to realise the benefits of economic growth. Regulated assets include water utilities, electricity transmission and distribution, and gas utilities.
User-pays assets have revenues that are based on how many people use the assets. These assets often have built in inflation protection, such as price increases explicitly linked to inflation, however, these are heavily impacted by activity levels in an economy. User-pays assets include rail networks, toll roads, airports, and ports.
Why do we invest in infrastructure?
Infrastructure assets have unique attributes which can add value to a portfolio. This includes reliable cash flows, inflation protection, lower risk of capital loss and, low correlation with other types of assets.
In a weakening economic environment, corporate earnings are placed at risk. This is often not the case for infrastructure companies, which can then outperform in a weak economic environment.
Through these attributes, infrastructure can provide protection, while also providing upside for capital growth and income generation. In other words, infrastructure can improve portfolio returns while also reducing risk in a portfolio.
Infrastructure market outlook
From a risk perspective, infrastructure remains challenged by potential regulatory risks and geopolitical issues related to existing and future government policy. Despite this, we see several tailwinds that will be supportive for infrastructure returns over the next few years:
- Performance trends: Infrastructure tends to underperform global equities when economies are strong and growing well. Infrastructure also tends to perform poorly in periods of rising interest rates, as this creates adjustments in the valuation for these assets. Both these factors were present in 2023, so infrastructure returns were poor relative to long-term averages. Historically when this has occurred, infrastructure has generally outperformed in the subsequent two years. We expect interest rates to begin to fall in the second half of 2024, which would also provide a tailwind for infrastructure returns.
- Government infrastructure projects: Many governments around the globe made very large infrastructure spend commitments over the past 3 years. These projects include the replacement of existing infrastructure in developed markets, as old and inefficient infrastructure is upgraded or replaced.
- Renewable energy transition: The widely targeted goal of achieving Net Zero emissions requires very significant spend on infrastructure projects. This includes upgrading electricity grids to support future electricity transmission requirements, as well as producing new energy sources such as solar and wind turbines.
- Demographic shifts: Western populations are getting older, while Eastern populations are getting younger. The West will require new infrastructure to support older generations such as more hospitals, while the East will require new infrastructure to support growth such as more toll roads. The emergence of a larger middle class in many emerging markets also requires new infrastructure, such as new airports as more people around the world can afford travel.
- Technological change: New technology requires new infrastructure, such as data centres to support the growth of cloud computing.
We continue to see value in holding infrastructure in a well-diversified portfolio.
If you are interested in learning more about our PSK investment portfolios, please contact your PSK Adviser or get in touch here.
General Advice Warning - Any advice included in this article has been prepared without taking into account your objectives, financial situation or needs. Before acting on the advice, you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs.
