What does infrastructure consist of?
By infrastructure, we generally mean assets related to the provision of essential services that are critical for the functioning of society.
We all depend on infrastructure assets in our everyday lives – utilities that provide us with electricity and water; roads, airports and public transport that allow us to travel; and digital networks that support communications and payments.
Infrastructure serves as the backbone of the global economy through good times and bad. We believe that investing in companies which own or control strategic physical assets can have an important part to play in investors’ portfolio over the long term.
Listed infrastructure businesses often have the following characteristics:
- Critical long-term assets covered by long-term contracts
- Revenues indexed to inflation
- Stable and growing cash flows
Given the essential nature of infrastructure assets, they tend to exhibit fairly consistent demand. This means their cash flows tend to be relatively predictable and enduring. By focusing on companies that can turn stable and growing cashflows into growing dividends, we believe that listed infrastructure represents a potentially attractive source of opportunities for long-term investors looking for regular and growing income.
Why invest in listed infrastructure?
Infrastructure plays an important role in our modern society, providing the services that are critical for social and economic activities.
In our view, listed infrastructure is also exposed to multiple thematic tailwinds, which could support strong growth for many decades to come. Renewable energy, digital connectivity and demographics are powerful enduring themes, which we believe represent exciting long-term opportunities for the asset class.
Importantly, we believe infrastructure is central to the solution to many of the world’s most important and pressing issues: climate change, energy security, the need for social infrastructure and an increasingly digital society, to name but a few. Addressing these challenges could be a source of growth for infrastructure companies in the coming years.
Supporting the energy transition
In the case of climate change, the infrastructure sector is expected to play a pivotal role in the energy transition and the move away from fossil-fuel based energy production to cleaner, more sustainable sources of energy.
The increasing incidence of extreme weather events and the havoc they bring to communities around the world provide a constant reminder that the task is urgent. According to consultants McKinsey, at least US$50 trillion in investment will be required to reduced emissions by 2050 in order to meet the goals of the Paris Agreement.[1]
Governments are increasingly introducing measures to address climate change, most notably the Inflation Reduction Act of 2022 in the US, which provided billions of dollars for investment in clean energy and climate action.
These policies and incentives represent powerful support for the transition, in our view, and could create a favourable tailwind for the asset class. As a major source of global carbon emissions, the utilities sector is likely to be central to this process, through the development of renewables, the reconfiguration of grids to accommodate new sources of energy, and the development of low voltage networks fit for the modern age.
While utilities is arguably the sector most closely involved in the energy transition, other types of infrastructure companies can potentially contribute to the decarbonisation of the global economy. These include transportation businesses, energy firms that are providing transition fuels, such as natural gas, and companies developing the fuels of the future, such as hydrogen.
Increasing energy security
Another important factor related to the energy transition is energy security. The war in Ukraine and the subsequent spike in energy prices provided a stark reminder of the importance of establishing secure energy supplies. In order to reduce the risk of future energy shocks and supply disruptions, there has been increased focus on ensuring access to reliable energy resources.
A key element of this has been a greater push to develop domestic energy supplies, particularly renewables, and establish new supply routes. Both of these are likely to involve infrastructure firms, be that utility firms, the providers of clean technology such as wind turbines or the operators of gas pipelines and grid networks. As a result, infrastructure assets can be considered an essential aspect of both addressing climate change and improving energy security, in our view.
Inflation protection
Over the past couple of years, inflation has been the dominant issues for investors globally. Prices have been rising significantly, driven largely by increases in the cost of food and energy. Although the headline rate of inflation in major developed economies has gradually come down from the 40-year highs it had reached, it still remains above central banks’ targets.
It is widely anticipated that inflation is now likely to be a persistent risk factor and price increases could remain elevated. In an environment of higher inflation, investors have started looking for assets that can provide some defence again the corrosive effects of price rises.
We believe that listed infrastructure can provide some protection in these inflationary times. In many cases, the income from infrastructure assets is indexed to inflation, and therefore rises when inflation goes up. 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.
In our view, investing in infrastructure therefore offers the potential for inflation protection by way of index-linked revenue, which can translate into growing dividend payments. We believe a rising income stream represents an effective hedge against inflation over the long term and in many cases we see infrastructure companies deliver real dividend growth in excess of inflation.
Embracing Artificial Intelligence
Artificial Intelligence (AI) has been the dominant theme in equity markets this year, but NVIDIA is not the only beneficiary of this burgeoning technology. AI can help infrastructure businesses to reach new levels of efficiency and ultimately enhance long-term growth in the asset class.
For example, listed infrastructure provides exposure to the explosive growth in AI by way of data centres, which are critical to AI’s success given the ongoing demand for computational resources. The more AI expands, the more processing capacity is required, which requires more space. In our view, the growth of AI and other technology is likely to bode well for revenue growth and pricing power at data centre companies that are in a position to meet future demand for server storage space around the world.
AI also has the potential to revolutionise the asset class in other ways, such as facilitating the development of smart grids, which will help optimise electricity distribution and consumption; playing a crucial role in optimising water resource management; and enabling transportation infrastructure companies to leverage AI to improve mobility efficiency and safety.
We are merely scratching at the surface. By incorporating AI, infrastructure is potentially embarking on a new era where the qualities of its critical assets become even more appealing.
Exciting prospects
We believe that the long-term prospects for listed infrastructure are extremely exciting. Not only does the asset class offer the potential for inflation protection in the current environment, by virtue of index-linked revenue, in our view, it is also it is a beneficiary of multi-decade trends that could deliver long-term growth opportunities.
This year, there have been some concerns about the impact of higher interest rates on infrastructure businesses, particularly those with high levels of debt – utilities and companies structured as real estate investment trusts (REITs) have borne the brunt of negative sentiment this year.
However, at times, we believe that investors can become overly pessimistic about companies that are perceived as interest-rate sensitive. As long-term investors, we think the sell-off could provide the attractive opportunities to invest in out of favour businesses where the long-term growth prospects remain intact.
With valuations in certain areas at levels we consider to be very attractive and tailwinds from powerful structural trends such as the energy transition, digital connectivity and demographics, we are extremely optimistic about the long-term potential of listed infrastructure.