Why we believe infrastructure equities will outperform a volatile (down) market

The recent collapse in bond yields, driven by central bank rate cuts across many major economies, has increased fears of a global recession. This, in turn, has led to equity market volatility and growing expectations of a market setback, as investors seek safe-haven assets. However, we strongly believe that infrastructure equities will perform well in this environment, given their defensive characteristics, the relatively low exposure to wider macroeconomic factors, the secular growth drivers within the infrastructure sectors and the attraction of the underlying assets to investors seeking long duration, low risk assets as an alternative to expensive bonds.

We believe that in the current environment, where sovereign and investment grade bonds are becoming increasingly expensive, we will see increased interest in infrastructure assets as a low risk alternative for long-term investors. There is nothing new here; the attractiveness of these assets to financial buyers such as sovereign wealth funds, pension funds and private equity investors (including Warren Buffet’s Berkshire Hathaway) is well-established. However, as falling bond yields make the need to find alternative investments more acute, we believe that attention will increasingly be focused on the listed infrastructure area, where relative valuations remain attractive despite recent strong share price performance.

It is instructive to note that two infrastructure equities, the Canadian energy midstream company Inter Pipeline and the US-listed renewable energy stock Pattern Energy, have each received unsolicited but confirmed bids from so-far anonymous sources since the beginning of August. We can’t be certain that these bids are from financial buyers, but this would be consistent with the trend of off-market bids for infrastructure stocks in recent months. Examples include IFM Global Infrastructure Fund’s USD 6.5bn acquisition of energy infrastructure stock Buckeye Partners and the Infratil / Brookfield acquisition of Vodafone New Zealand for NZD 3.4bn, both in May 2019, JP Morgan Infrastructure Investment Fund’s bid for the US regulated utility El Paso Electric for USD 2.8bn in June 2019 and Brookfield and GIC’s purchase of US railroad Genesee & Wyoming for USD 6.4bn in July 2019. In addition, we have seen numerous examples of private equity funds buying infrastructure assets from quoted companies, including Macquarie’s Green Investment Group buying a 40% stake in Iberdrola’s East Anglia One wind project for GBP 1.6bn in early August 2019.  

So, what is the attraction of the sector to these long-term buyers, and why should investors see listed infrastructure stocks as a safe haven area? And how would we counter the view that these stocks are fully valued after strong recent gains? Taking the US regulated utility sector, the Miton Global Infrastructure Income Fund’s largest individual country and sector weighting, as an example, the sector is, according to analysts at RBC, trading close to its highest premium over the last decade versus the wider S&P 500 Index.

In a recessionary environment, with many stocks potentially impacted by the negative consequences of a cyclical downturn, exacerbated by trade tariffs, we are likely to see earnings downgrades across the wider equity market. However, we are confident that, regardless of the macroeconomic background, we will see mid-single digit earnings growth from the regulated utility stocks over the next five years, and potentially beyond. This growth will come from rate base growth at the utilities, driven by two main factors. Firstly, the need to replace and maintain existing networks to continue to provide essential services and also to facilitate developments such as the widespread adoption of electric vehicles and two-way “smart-grids”. Secondly, to invest in the energy transition from coal-fired electricity generation to wind and solar, where the falling costs of these renewable technologies make this replacement cycle not only environmentally desirable, given the resulting reduction in carbon emissions, but also economically attractive in providing cheaper electricity to consumers.

This visibility of this earnings growth, which will happen regardless of macro-economic cycles, trade wars or other external influences, is what could make this sector very attractive to long-term investors. Investors in listed infrastructure also get exposure to other areas of growth such as communications, and the huge growth in high speed fixed and mobile data, which again we believe is a secular trend which will continue regardless of a deteriorating macro-economic backdrop. So, investors get exposure to a combination of long-duration assets with the potential to provide resilient returns, but also to long-term growth drivers. In addition, in an environment of falling interest rates, many infrastructure stocks with investment-grade credit ratings can benefit from a lower cost of debt as they refinance existing bonds or use debt to fund the growth capital expenditure that we’ve highlighted. For regulated assets, the benefits of the lower cost of debt will be passed through to the end-consumers. However, for unregulated infrastructure assets, the lower borrowing cost will enhance equity returns, and, returning to the earlier theme, cheaper debt available to potential acquirers of listed stocks enables these buyers to pay higher premiums to the market value of equity.

In a severe equity market setback, there is no doubt that infrastructure stocks could be caught up in a wider tide of selling, and we could see share prices fall. However, based on the factors discussed, including the resilience of earnings, the ability to grow profits even in a recessionary environment, the positive influence of lower interest rates and the attractiveness as acquisition candidates to long-term financial investors seeking low-risk alternatives to fixed income assets, we believe infrastructure stocks have the potential to outperform the wider stock market in this scenario, and could provide a welcome safe haven for investors.

Risks:

The value of stock market investments will fluctuate, and investors may not get back the original amount invested.

The past performance information presented in this article relates to the past. Past performance is not a reliable indicator of future returns.

For funds investing globally, currency exchange rate fluctuations may have a positive or negative impact on the value of your investment.

This fund may experience high volatility due to the composition of the portfolio or the portfolio management techniques used.

The fund will invest predominantly in companies that have exposure to infrastructure. This can mean the fund is more sensitive to price swings than other less concentrated funds.

Forecasts are not reliable indicators of future returns.


Important Information:

For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.

Source for sector performance: FE Analytics, as at 31/07/2019, bid to bid basis.

The views expressed are those of the fund manager at the time of writing and are subject to change without notice.  They are not necessarily the views of Miton and do not constitute investment advice. Any mention of a specific stock is not a recommendation to buy or sell.

The Prospectus, KIID and application forms for the LF Miton Global Infrastructure Income Fund are available in English from the Authorised Corporate Director of the fund, Link Fund Solutions, at www.linkfundsolutions.co.uk ; or from Miton, the Investment Manager of the fund, at www.mitongroup.com.

This financial promotion is issued by Miton, a trading name of Miton Asset Management Limited the Investment Manager of the Fund which is authorised and regulated by the Financial Conduct Authority and is registered in England No. 1949322 with its registered office at 6th Floor, Paternoster House, 65 St Paul’s Churchyard, London, EC4M 8AB.

MFP19/354.