1. The risk/reward characteristics of global infrastructure and its correlation to equities and bonds
2. The drivers of growth in the global infrastructure market
3. How global listed and private infrastructure differ from each other
PRESENTER: Well, Peter Meany, first of all what’s your working definition of infrastructure and the subsectors under it?
PETER MEANY: Look I think infrastructure, there are quite a range of definitions out there, and it’s really important, before we go into any of these questions, to define what is core infrastructure? We invest in companies that have very high barriers to entry. So they’re pretty capital intensive, monopoly, you know, regulated, contracted businesses that are very difficult to replicate. We’re looking for businesses that typically have pricing power, so the ability to pass through prices year after year, and I think in a low growth environment clearly that price become more valuable. We’re looking for growth that is more structural and cyclical. So hopefully through a full economic cycle our companies are just consistently delivering earnings growth. And not focused on the broader economic cycle, the commodity cycles, that consistency is important.
So companies’ assets that tend to fit into that definition, I guess on the more bond-like assets, think of utilities, contracted pipelines, and we also have quite a few growth infrastructure, think of roads and airports, through to mobile towers and maybe LNG terminals, so quite a range of things but a combination of defensive assets.
PRESENTER: So you said LNG terminals, what are those?
PETER MEANY: Liquefied natural gas, so as you’re probably aware there’s an enormous amount of gas for example being produced from shale in the US. The US’s domestic economy is consuming as much as it can but there’s a surplus. So how can we get that gas to other parts of the world? We need to build infrastructure. So we need to build the pipelines, you know, the gathering systems, the transmission pipelines. Bring it to a terminal, an export terminal. We liquefy the gas, compress it if you like, and then put it on a ship and transport that around the world. So it’s a good example of the extra infrastructure that’s needed in a globalised economy.
PRESENTER: You were saying earlier there about you like to invest in companies that have high barriers to entry, good pricing power, sustainable growth. In a sense any equity manager would say that’s what he or she is looking for. Are these characteristics that are particular to the infrastructure space?
PETER MEANY: We think they are, and I think the proof is in the pudding. If you look at the risk-adjusted returns from infrastructure over 10, 15, 20 years, or the nine years that our fund’s been running, you know, it has delivered a unique risk adjusted return. Lower volatilities, higher returns, less downside capture. And I think in a world where growth is lower, returns are expected to be lower, given where bond yields are, having that risk returning characteristic is clearly attractive.
PRESENTER: Well taking a step back for a moment, is there a good global index that’s a proxy for the infrastructure space?
PETER MEANY: Short answer is no, there’s no perfect index and there are a range. Managers in this space use quite a different set of benchmarks. And that can be telling about their style of investing. There are some benchmarks that are very equity like. Think of the S&P infrastructure index. There are some that are very bond like, think of the Dow Jones, Brookfield. We tend to invest through a full cycle. We want a combination of those characteristics. So we use the FTSE Global Core Infrastructure 50/50 Index. It rolls of the tongue of course, but it speaks to what we do.
We’re global. We think there’s opportunities all round the world. It’s core, so very tangible, pure infrastructure assets. And it’s 50/50, which is half utilities, regulated contracted business. They give us the ballast to the ship if you like. And the other half is more transport and other growth infrastructure like towers and pipelines. That combination we think is important to perform through the whole cycle.
PRESENTER: And how big is the infrastructure market overall? Can you give us some idea of what’s driving that growth?
PETER MEANY: The listed infrastructure market is around $2trn in free float. So a very large universe of stocks, about the size of the global REITS sector to give you a comparison. That could be 250-300 stocks that would broadly sit into that area. We screen that down significantly, trying to get those core characteristics we talked about earlier. So in terms of our focus we think there’s about 120 stocks that meet that criteria, and out of those 120 we tend a build a portfolio of around 40 stocks for our investors.
PRESENTER: And when you look at that universe of listed infrastructure stocks, how has it been changing over the years, particularly as we see things like the rise of the emerging markets?
PETER MEANY: Yes it’s evolved a lot both in terms of sector and geography. In terms of sector 10 to 20 years ago infrastructure was dominated by utilities. So they tended to be quite low growth. Some global equity managers would say boring. But that’s fine, that serves a purpose in our portfolios and I’m sure in general portfolios. But what’s evolved in the last 10 years is that we’ve seen a much broader range of infrastructure assets added. As mentioned a lot of the transport assets have been privatised, so more toll roads, more airports, some railroads, which is helpful. Also relatively new things like the mobile tower. I mean mobile data if you think about it has only really evolved in a significant way in the last five or 10 years in terms of the very strong need for mobile towers to provide that iPhone or iPad quality of signal. And as a result of that where we sit today we’ve got a much more rounded set of opportunities spread across sectors.
In terms of countries, you’re right, there’s been additions to the universe from everywhere. If I think about Europe, we’ve had the world’s largest airport operator AENA that owns Madrid and Barcelona, 40 other airports, float 18 months ago, so that’s certainly added to our airport universe. We’ve had a lot of assets come out of integration or conglomerate companies. So port companies that have come out of the Hutchison Group, pipelines that have come out of Shell and big integrated oil companies, and of course increasingly we expect government privatisations, given the amount of debt that governments hold today, to further add to the universe.
PRESENTER: Is there a danger, I mean people have been talking about infrastructure for a few years now, is there a danger it becomes a pretty crowded trade?
PETER MEANY: It’s always a danger in any capital market when you’ve got a good thing and capital is looking a home, particularly when bond yields are paying very low returns, it’s natural that you will see capital flow to this space. I would contrast in a way the environment in private infrastructure markets with public markets. So a bit of background, clearly as pension and sovereign wealth funds have looked at infrastructure as an asset class, their preference has been to invest in private or direct, either owning the assets directly or investing in a private infrastructure fund. That makes perfect sense. You know, to own the assets out of the volatility of markets, a sense of control over those assets as a large owner has a lot of merit. And the returns historically have been very attractive. And that’s where I would say 90% of the capital that’s gone into infrastructure has ended up.
That is an area where we are seeing challenges in terms of sourcing scarce infrastructure assets, and paying a reasonable price for those assets. As an example London City Airport was sold for some 28 times EBITDA. In the listed market we’ve got airports like Paris Airport at 10 times EBITDA, or Sydney Airport at 20 times. So you can see that differential in valuation. The result of that is we are seeing more interest in listed infrastructure from pension funds and wealth funds, private banks etc. And we’re also seeing take privates, and that is with all this capital building up in the private infrastructure sector, they’re saying well I need to put this money to work, one way I can do that is come in and take over a public equity, a listed company that we invest in. And we’ve seen for example a whole range of takeovers, for us one a year at a 35% premium. So that’s a nice little cream on the cake for our investors.
PRESENTER: But how would you say listed infrastructure differs in risk and reward characteristics from private infrastructure?
PETER MEANY: Yes, look, you’re investing in the same underlying assets, the same types of assets, and core infrastructure has been available in both areas. Clearly the benefit of private infrastructure is you don’t have that mark to market volatility. So valuations are done typically every six or 12 months, so a bit like direct property more stable outcomes. In the listed infrastructure market the advantage is that you have a high level of liquidity, so investors can move in and out. We as active investors can move positions. There’s a bit suite of diversification as we mentioned at the start, so we can build a very diversified portfolio overnight. The challenge of course is that we’re in equity. So if equity markets rise or fall we will fall to some degree.
Now the history has shown, you know, of the benchmarks of our strategy that correlations can be quite low. We’ve seen a beta in down markets of about 0.5, 0.6 to the MSCI world, so falling half as much, and importantly in terms of upside capture giving you 80 or 90% of the upside in rising markets. So that combination of protecting in down markets, capturing most of the upside in up markets. If you look over three, five, seven years, you end up with a very similar outcome, although a different path.
PRESENTER: And what about correlations to other asset classes like bonds or property?
PETER MEANY: It depends on which sector we’re looking at. I think the correlations to property have been quite low, because I think property has other drivers of their valuations. And certainly in the global REITS sector we’ve seen a lot more volatility in that space compared to infrastructure. When it comes to bonds it depends on what part of the spectrum of infrastructure we’re looking at. Fair to say that the very low growth regulated utilities will have a higher correlation to bond yields, and certainly rise bond yields as we’ve seen recently will be a headwind for that sector; pipelines in the US tend to be an income focus centre, so a bit more sensitive. But many other sectors, the transport side, you know, mobile towers for example, are less dependent on bond yields.
PRESENTER: But in essence do you think listed infrastructure is an asset class in its own right, or an interesting theme fund within the equity space such as you might buy technology or financials?
PETER MEANY: You can either way, and look we don’t tell our investors how they should think. What we tend to do is say, here are the characteristics we think we can give you: 3-4% yield, 5-6% growth in that income, some inflation protection, a beta of 0.5 in down markets. These are the characteristics we feel we can deliver; you tell us where it best fits in your portfolio. And the answer to that varies. We’ve had investors who have taken money from property and added infrastructure as a complement. We’ve had investors that have seen us a global equity income low vol strategy, so it’s an income. More recently I think what we’re seeing is a lot of investors are carving out real assets. And while their focus is more on private markets they’re adding say out of a 5% allocation to infrastructure, they’re saying we’ll do 1 or 2% listed and the rest in private markets. So it depends on what the investor is looking for.
PRESENTER: And you mentioned that income of between 3 and 4%, how sustainable is that, how durable is it?
PETER MEANY: I think history has shown it’s very sustainable. In terms of the income that’s produced all the way through the financial crisis of ‘08/09, through the Euro crisis, varied other events, terrorist attacks, earthquakes, whatever it might be that’s hit us in the last 10 years, what we have seen is a very consistent flow of cashflows and income from these assets. And it reflects the nature of the assets. They’re established, regulated, contracted, cashflow generating assets. In the listed market payout ratios are very reasonable, so they’re only paying out 50-60% of their earnings. So there’s scope to, even if there is a pullback in earnings they can still pay that dividend. And leverages is a very comfortable level in the listed market. So a rising bond yield won’t materially impact the earnings or dividends available.
PRESENTER: The other thing you mentioned there was inflation protection. We’ve not had a lot of inflation recently but why do you think infrastructure is a good inflation hedge?
PETER MEANY: Well firstly if you look logically or fundamentally at how the assets are structured, it makes sense. More than 70% of infrastructure assets have a direct link to inflation. And that is last quarter’s inflation number is next quarter’s price increase. So there’s an automatic recovery of inflation in a lot of the regulated contracted businesses. And if there isn’t an automatic increase we have other businesses where simply because of lack of competition they’re a monopoly or duopoly market structure, they simply can pass through price increases year after year. So that's the background. We can also prove it statistically, at least historically, over the last 15 years, there’s a strong positive correlation between infrastructure equity outperformance versus the MCSI world and inflation, so the higher inflation goes, the more infrastructure has outperformed.
PRESENTER: And what would you say are the long-term drivers of infrastructure if we look out over say the next 10 years?
PETER MEANY: Yes, look, I think there’s a series of drivers depending on which sector we’re focused on specifically. If I looked at the utilities space, you’ve got two main drivers. One is the repair and replacement of old networks. So a lot of networks were built in the ‘70s, with a 30-year, 40-year life. We need to replace out those old water pipes, old gas pipelines to make them more structurally sound. And that reinvestment in new pipes adds to the asset base, which delivers long-term growth. The other area in utilities is renewables. The mandated requirement for utilities to have 20, 30, 50% of their electricity coming from renewable sources requires a significant amount of investment. So wind farms, solar panels might be the obvious area to invest, but we also need electricity transmission lines to tie those in. We need battery storage, we need smart meters. There’s a whole range of investment that needs to take place to decarbonise our systems in utilities.
Without going into every sector, think about mobile data. Everybody, the exponential demand for iPhone, iPad usage is driving demand for more towers, so that the quality of that signal is higher. Think about security of energy supply. As mentioned with the LNG terminals, with the pipes, getting that cheap shale gas to market requires infrastructure, so a range of long-term drivers.
PRESENTER: To what extent have you got discretion on whether you class something as infrastructure or not? Because you’ve mentioned a couple of trends there that maybe if we’d had this conversation 15 years ago these things wouldn’t have existed like mobile data.
PETER MEANY: Yes, look, we’re very long-term investors. We have a clear view of what our definition of infrastructure is. Fair to say that universe has not changed a lot in the last 10 years since we’ve been running. So the consistency of names is there. That said we do need to evolve our thinking from time to time, and address some of the new risks and challenges that are coming up. Five years ago we were very sceptical on renewables. I didn’t want to invest, our team didn’t want to invest in an area of the market that required government subsidies. But the economics of renewables have changed so much. Wind farms have moved from 30% utilisation to 60%. As they’ve got taller and the blades have got longer, technology has made them more productive. You need to evolve your thinking as that plays out.
So a clearly defined universe but we don’t want to stick our heads in the sand and not take advantage of opportunities, and not get caught in a risky situation where perhaps an asset becomes stranded.
PRESENTER: And you’re mentioning that some of the differences or the changes that are coming up, how does infrastructure development differ between I guess the developed world and the emerging world?
PETER MEANY: Yes, look, the emerging world is exciting in many ways in terms of the potential. The amount of infrastructure that needs to be built is being built around the world. It creates a lot of growth opportunities. The challenge with that though is that how do you translate that theme into a good stock idea. And that is not easy in emerging markets. You can’t take a utility or a pipeline or a railroad and move it. It’s a domestic play. So we have to be confident in the property rights of a country. We need to be comfortable in the legal system to defend a contract. We need to be comfortable that there’s separation between politics and regulation. So here in the UK while there’s always political noise around issues, Ofgem, Ofwat, the regulators do have an independent system. There’s an established framework, and they generally make very sensible decisions for investors.
As we go into emerging markets those lines get blurred, and we have to be very careful that a great theme, a great story actually translates into a good risk adjusted return. So we’ve typically only had 5 or 10% of our fund in emerging markets.
PRESENTER: And how do you see that perhaps changing over time?
PETER MEANY: I would like to see it increase, but it has to come with a low level of risk or a significant amount of value to compensate for that risk. I would hope that over time many emerging markets would improve some of those areas in terms of more established regulatory frameworks, more transparency of regulatory decision, contracts that were defendable in court. If a lot of those ingredients get put in place, and it is improving. I think Brazil has been an example where we have seen significant improvements, Mexico another example. Things are improving, opportunities are growing, but we’re still going to remain very cautious to deliver that stable return to our investors.
PRESENTER: Well you’ve touched on it a little bit already, but I’d like to go in a bit more detail of what some of the risks are involved in infrastructure investing. Now you mentioned political.
PETER MEANY: Yes.
PRESENTER: Is that just an emerging market problem?
PETER MEANY: No, it’s a risk everywhere. The number one risk is political and regulatory interference, and everywhere in the world that is present. Whether you look at here in the UK, the significant amount of pressure that’s been put in regard to retail margins that the utilities are earning, if you look at the US and the current debate between Trump and Clinton around their policies on coal versus renewables, there are lots of things to navigate. And it’s not just an emerging market issue. I guess the advantage of being in liquid markets is that we can evolve. As policy change occurs, we can sell positions leading up to a draft regulatory decision that we expect to be negative. We can build a diversified portfolio so we spread some of those risks, unexpected risks. And as an active manager clearly we believe that doing that on the ground due diligence, meeting with regulators, meeting with politicians, understanding those risks as best as we can is a key part to navigating that.
PRESENTER: What about currency?
PETER MEANY: Currency is a challenge. I guess from an investment standpoint we are bottom-up stock pickers, and we very much focus on the fundamentals of the assets of the company, and with a globally diversified portfolio, you know, there’s pluses and minuses as currencies move around. So we tend to be bottom up but in this world you can’t ignore macro drivers including currency. So I would say build things bottom up fundamentally, but perhaps top down we can make some small adjustments to the portfolio to, I guess for example we might sell Zurich Airport a little bit earlier because the currency has just been so strong. We might be inclined to buy into a UK business today given that sterling has been so weak. From an investor point of view I think the combination of unhedged and hedged share classes gives investors the opportunity to make that decision as well.
PRESENTER: What about just things like natural disasters? I mean presumably if you’re a utility, I think of something like the Fukushima plant in Japan, I mean how big a risk is something like that?
PETER MEANY: Yes, look I mean clearly a nuclear power station in an earthquake zone is probably not a good place to start investing, and that’s a part of our universe that we have screened out. But yes, clearly these are very capital intensive assets, very large assets. And earthquakes by their nature could have impacts on these very large capital intensive businesses. I guess how do we manage that? I think first of all sensibly thinking about whether this is a single asset exposure, or is it a network? And I think about for example Atlanta in Italy. There’s been some earthquake activity there recently, some tragic events. But if we invest in something like Atlantia, the auto strata network, there’s thousands of kilometres of network in place, and very hard to see a single event rendering a material impact on the scale of that network. Of course in a portfolio we can also spread those risks across countries, across sectors, across assets to try and minimise that impact.
PRESENTER: And also at a stock level, I mean there must be companies that are utilities that for whatever reason fail. Are there some fairly common things that they get wrong?
PETER MEANY: Obviously it’s our job to try and not own those failures, but inherently we will get things wrong as investors. And I think of an example, we did own E.ON the German utility. And I think as an investor making mistakes over a period of time. There was one where we were a bit slow to recognise the significant impact that renewable energy was having on that market. And the reduction in value that we saw for say coal fired generation assets for E.ON’s utility. We also didn’t expect the very significant political change that occurred there in terms of the government shutting down nuclear in Germany.
So there are things that despite the effort you will get wrong from time to time. I think firstly it’s about having a portfolio that can minimise or work with that risk. Secondly it’s about learning from that. And clearly we’ve learned from that mistake, and the investments we’ve made now in the US utility space were renewables are perhaps five, 10 years behind part of Europe, we’ve learned from that and are now benefiting from that developmental change in another part of the world.
PRESENTER: You were mentioning there if you’re a company in this space it could be pretty capital intensive in places. Do you worry about utilities carrying too much debt, low interest rate environment at the moment, might not be that forever?
PETER MEANY: I worry about leverage and I worry about rising bond yields for the asset class. I think that we do have a portfolio of companies that reflects that risk. I think you can built a portfolio globally that has very comfortable levels of leverage, you know, three-and-a-half times cash interest cover, so interest payments being covered three to four times gives a lot of flexibility to deal with that risk. The other thing that we’ve seen is our companies have learned from the financial crisis, and leverage is lower today than it was in 2005/06/07. Companies have also recognised these low interest rates probably won’t be around forever, so they’ve extended the maturity of their debt a lot. And I can think of an Australian toll road Transurban that now has an eight-year maturity on its debt, compared to say four years if we go back five years ago. So they’re extending that maturity which reduces the risk of rising interest rates on earnings.
PRESENTER: Talking in quite general terms about the sector and subsectors within it, but could you give us an example of a really good high quality infrastructure investment? And not just why it’s a good company but why it’s a good investment, so I guess the valuation piece as well there.
PETER MEANY: Yes, look I think it’s a very important combination of things. There are some very high quality infrastructure assets and that’s half the equation. If I think about our highest quality company, it is Transurban, an Australian toll road company, and I apologise for my bias to Australia. But Transurban for example has a network of toll roads in Brisbane, Sydney and Melbourne, and Northern Virginia around Washington DC. These are long-term concession agreements that have been reached with the various governments. The surrounding public roads have by nature had very little investment, so all of the population increase, vehicle travel is being funnelled into these private toll roads, and as a result they’re achieving good organic volume growth.
They also have pricing agreements that allow them to increase prices every quarter by inflation. And in some cases the agreement is the greater of inflation or 4%. So 4% price increase every year with volume growth. Layer onto that they’ve been able to negotiate with governments to do some improvements on those roads. Widen the roads, add a new entry or exit ramp, introduce electronic tolling to free up congestion points. All of these things have layered in growth, and they’ve been able to achieve 10-12% cashflow or dividend growth in recent years, and we expect that to continue in the next five or 10 years.
An independent board, very strong management team, safe pair of hands, comfortable level of leverage, a strong focus on sustainability, so a lot of community programmes, very high customer satisfaction, very good governance in terms of its chairman and board – that combination of things is what a quality infrastructure company is.
PRESENTER: Isn’t there a danger though that if you compound your pricing at 4% a year you’re going to get some very dissatisfied customers?
PETER MEANY: Well that’s why you have to provide a very good service. Clearly as the compound nature of that kicks in, and prices do increase from $2 to $4 to $6 to get to work in the morning you’ve got to provide a very good service. You’ve got to save the customer time. And if you can save 10, 20, 30 minutes on a commute to work that’s valuable to a car. If you’re a freight or a truck operator moving a million dollars of goods around an orbital route that bypasses the city, if you can provide a service that saves that truck 30, 40 minutes, that’s incredibly valuable. So what we’ve seen to date is almost no price elasticity. So as they’ve increased tolls there’s been no reaction from volumes. Now they will need to continue to provide a very good service, but for now that’s certainly the case.
PRESENTER: And as a company like that looks to the future, do you want them to go around and build roads in other parts of the world, or do you worry that actually no just keep the cashflows coming to me now and for the next five to 10 years?
PETER MEANY: That’s a very important discussion we’ve had with the chairman and the CEO, and something that we have a very clear view on. They should stick to their existing focus. They have very strong networks in Australia and in Virginia as mentioned. And the amount of work that’s still to be done on those assets is very significant, you know, $10-12bn of potential projects, and why not focus on those areas where you have a core competency and a competitive advantage? It’s where the independence of the board, a strong management team is just so important. Predicting cashflows for the next 10 years, that’s the easy part; what management do with those cashflows, what regulators do with those cashflows, that’s the risk.
PRESENTER: Now we’ve got a couple of minutes left so I wanted to just start to bring this to a bit of a conclusion Peter. One thing I think I’d be interested in is to get your thoughts on who the natural buyers of infrastructure are today, but also over the next five and 10 years?
PETER MEANY: I don’t think the natural buyer should be concentrated in any one area. I think the assets just make sense as an investment. Clearly I’m biased. But if you’ve got a set of assets that are simple to understand, everyone knows how a utility, a toll road and an airport makes money; they’re tangible simple assets. In a world that’s going towards needing more income, in a world that is at or past retirement and can’t afford high volatility, having a more defensive income generating set of assets simply makes sense as an investment. So we have investors for example from all walks of life. From sovereign wealth funds to very large pension funds to smaller corporate pension plans and local councils, private banks, multimanagers, IFAs, mums and dads. Why limit it? If it makes sense we would like to make it available to every investor.
PRESENTER: But why buy a specialist fund? Because I imagine a lot of people would watch this and say well it sounds great but I’m sure I’ve got some infrastructure assets in my global equities portfolio, in my UK equity portfolio, my European portfolio, why double my bets up?
PETER MEANY: It’s a valid question. I guess the first answer to that is on the evidence that we’ve seen you don’t have a lot of infrastructure in your portfolio today. Infrastructure is less than 2% of the MSCI world. So if you own a global equity portfolio you’re probably not going to get a lot of exposure to what we invest in in that general manager. The other thing is it is relatively niche. There are 15 toll roads, 10 airports, five mobile tower companies. Global equity managers just don’t spend a lot of time looking at those areas, because they are quite small compared to their massive opportunities in healthcare or telecom or technology. And if they do look at infrastructure, global equity managers tend to just camp there for a while. I’m worried about markets, I’ll just throw some money into utilities for a short period of time, because those things, they’re boring, they only deliver 6 or 8% return. Well, hang on, a 6 to 8% return would have been very good in the last 10 years, and frankly would have been better than the return you did deliver.
So we think just investing consistently in this space is important. Secondly, clearly I’m biased but a specialist manager, this is a relatively new asset class. There aren’t many managers in this space, there’s not a lot of focus on it, and we see a lot of mispricing opportunities. A lot of potential to produce alpha, and so having a specialist active manager that can navigate those risks, take advantage of those opportunities, you know, can deliver an extra return above and beyond what the asset class can do.
PRESENTER: So what would you say in summary that listed infrastructure adds to an overall portfolio?
PETER MEANY: I think it gives a source of income in a world where there isn’t a lot of income available. It provides equity-like returns but in a more defensive way. It provides a degree of inflation protection. It’s in a set of assets that are simple to understand. When you go into the absolute return world, the hedge fund world, simple people like myself, it’s hard to understand. You can understand how a utility or an airport makes money, you use them every day. So I think that combination of things makes sense for an investor.
PRESENTER: We have to leave it there. Peter Meany, thank you.