Listed infrastructure and inflation

What does infrastructure consist of?

By infrastructure, we generally mean assets related to the provision of essential services for the optimal functioning of society. These are fixed assets that we all depend on every day, such as utilities that provide electricity and water, as well as toll and railways that allow us to travel. Infrastructure can also be social (related to health, education or security) or technological (related to communications or transactions).

These businesses often have the following characteristics:

• Long-term assets covered by long-term contracts
• Revenues indexed to inflation
• Stable and growing cash flows

These cash flows are relatively predictable and strike us as suitable for long-term investors looking for sources of regular and growing income. Their capital value may also be supported by fixed assets. 

Why invest in infrastructure?

Infrastructure plays an important role in our modern society and forms the backbone of the global economy. Infrastructure offers exposure to long-term structural growth trends, such as renewable energy, clean transport and digital connectivity. Therefore, we believe this asset class offers stable and regularly growing cash flows that can play an important role in investors' portfolios.

How does listed infrastructure perform in a more inflationary and volatile environment?

A sudden rise in prices

In spring 2021, consumer price increases were still considered a temporary phenomenon about which we had little to worry. Not even two years later, concerns around the increased cost of living are at the forefront. In April 2021, economists surveyed by Reuters were still forecasting inflation of just over 2% in the US and around 1.5% in the eurozone for 2022. It was 6.5% in the US at the end of December 2022 and 9.2% in the eurozone, although economists expect it to fall to 3.7% in the US and 6% in the eurozone at the end of 2023.

Rising inflation was also felt in equity markets. With markets now expecting inflation to be no longer temporary but higher for the long term , investors have started are looking for assets more resistant to the destructive effect of a general price rise.

Protection against inflation?

Traditionally, infrastructure investments have offered protection against inflation. One reason why some see infrastructure as a potential inflation protection is that much of the income from these assets is indexed to inflation. Contracts may stipulate that regular payments such as royalties must be linked to some measure of inflation. Inflation-linked payments may also be required by law, as is the case with toll roads in some countries.

Increasing volatility

Another issue currently worrying investors is volatility. The VIX Volatility Index, also known as the 'fear index', climbed to 36.45 on 7 March 2022, its highest point of the year. Although this index has since fallen, it still remained above 20 on 10 February 2023. The index was 17 at the end of 2021.

The war between Russia and Ukraine is not only a huge human tragedy but also the main factor behind the sharp rise in volatility in financial markets.

The risk of over-dependence on Russian gas has suddenly become clear, not only because gas is a politicised commodity controlled by an unpredictable regime, but also because it is transported through pipeline networks in Eastern Europe. The sudden rise in natural gas prices on the world market following Moscow's decision to stop supplies to several countries because they refused to pay Russia in rubles is just one example of how the Kremlin's political decisions can have a far-reaching impact on international markets.

Infrastructure has traditionally offered some protection against volatility. Data from the Global Listed Infrastructure Organisation (GLIO), an organisation that raises investor awareness of this asset class through research, education, events and promotion, show that listed infrastructure has outperformed international equities or global real estate over the past 20 years, with less volatility.

Perhaps one of the reasons why listed infrastructure tends to show lower volatility than the overall market is the greater predictability of earnings of companies in this asset class compared to equities in general and even Real Estate Investment Trusts (REITs), vehicles set up specifically to invest in real estate. This allows valuation to be assessed more accurately, even during periods of uncertainty.

A comparison before the pandemic between the evolution of earnings before interest, taxes, depreciation and amortisation (EBITDA), a measure of a company's financial performance, of companies in the GLIO index (a free float-weighted index that compares the performance of the largest and most liquid infrastructure companies worldwide) and global equities shows that in the 20 years before the Covid-19 pandemic, the earnings of infrastructure companies were more resistant than those of global companies in general. Past performance does not guarantee future results.

Global recovery from the Covid-19 pandemic will most likely require large investments in the asset class. Governments around the world have already announced a variety of infrastructure investment plans to support the global economy in the aftermath of the pandemic. In the United States, a $1.2 trillion programme has been launched to repair and modernise the crumbling US infrastructure. The European Union has embraced the Green Deal and wants to promote renewable energy and clean transport.

The transition to 'net zero carbon'

As environmental, social and governance (ESG) issues become increasingly important to investors and portfolio managers, infrastructure assets that contribute to the transition to renewable energy are becoming increasingly popular. According to Morgan Stanley estimates, $50 trillion in investment is needed to reach net zero by 2050. Even if we assume that only part of these investments will be realised, infrastructure still offers potential long-term opportunities that investors can try to exploit given its crucial importance for decarbonisation.

The infrastructure sector is enabling the transition to net zero through the use of cleaner forms of energy production and the reduction or capture of existing carbon emissions. Infrastructure companies using renewable or transition fuels, such as natural gas, and companies developing the fuels of the future, such as hydrogen, play a crucial role in the transition, in our view.

These policies may contribute to a favourable environment for the asset class, but it is not the only reason for our optimism. Indeed, in addition to renewable energy, we think listed infrastructure can also benefit from other structural trends, such as digital connectivity and demographics. These are promising issues that we believe will play a role for decades to come. In this climate, we are extremely optimistic about the long-term potential of listed infrastructure.