Infrastructure investing and rising interest rates
Investing in global infrastructure assets has been hugely popular over the past decade due to the unique and compelling characteristics of the companies involved and the returns on offer. Stable returns, relatively predictable cash flows and low levels of volatility have been highly desirable in the post-GFC world. The hunt for yield, as investors look to replace low-yielding fixed income assets with higher yielding alternatives, has driven demand across areas such as infrastructure, high dividend-paying shares and hybrid bonds in recent years.
In the 10-year period to the end of February 2018, the benchmark FTSE Global Core Infrastructure Index posted a total return of 9.0% p.a. in AUD-terms, which out-paced the MSCI World Index, at 8.6% p.a. with significantly less volatility, making it far-superior on a risk-adjusted basis.
As the interest rate environment has started to turn in recent months, infrastructure returns have suffered. Most funds available to Australian investors have seen drops in the range of 8-10% since the start of November 2017. This can partly be put down to an unwinding of the yield-hunting trade and partly due to infrastructure valuations being depressed by a higher rate discount. During that period U.S. 2 year Treasury yields have risen from 1.6% to above 2.2%, while 10 year yields have risen from below 2.4% to above 2.9%. At the same time oil and gas prices have been rising, putting cost pressure on many companies in the utilities and transportation sectors, in particular.
A buying opportunity?
Infrastructure companies, however, are often uniquely positioned to respond in such circumstance. Many companies operate under near monopolistic conditions and are able to control pricing to keep returns stable. Firms that are heavily regulated in this regard can expect the benefits of the economic growth that is pushing yields higher to provide a longer-term benefit that outweighs the immediate negative impact of higher rates. On the cost side, infrastructure companies tend to have lower than average debt-to-equity ratios and those firms that have raised significant debt financing are likely to have hedged some of their repayment liabilities against rising rates.
Infrastructure spending looks to be on the increase in 2018 and beyond, with significant Chinese investment and President Trump’s much discussed $1.5tn package of infrastructure spending. This could open up additional opportunities in the sector. Investors who subscribe to the view that infrastructure investing is for the long-term and who are looking to build a diversified portfolio that can perform in different market conditions may consider the current environment to be a favourable entry-point.
How does CORE compare to other infrastructure funds?
Unlike actively managed funds, CORE has a passive investment strategy which aims to track the Solactive Global Core Infrastructure Low Volatility Index (the “Index”). Each March and September, when the Index rebalances, it selects the 75 stocks with the lowest volatility from the global universe of core infrastructure companies, subject to size, liquidity and sector concentration constraints. The low volatility screening, designed to keep the returns as stable as possible, makes CORE unique as the only “smart-beta” offering in the infrastructure space in Australia.
Sector-wise, CORE is most over-exposed to Utilities and Telecommunications relative to its competitors, while regionally it is biased towards North America and Non-Japan Asia. CORE currently has no exposure to Australia. CORE also tends to have a slight bias towards mid-cap stocks relative to the other funds highlighted in Table 1.
Since inception CORE has outperformed the majority of its peers, including actively managed funds charging much higher management fees.
Over 10 years to 28 Feb 2018, the CORE’s benchmark index has outperformed the MSCI World Index by 1.72% p.a.
CORE is also approaching its next rebalancing, which is likely to see a rotation away from stocks that suffered the most in the volatile markets seen in early February, into stocks that should be less sensitive to rising rates in the US and general equity market volatility.
How to invest in global core infrastructure?
ETFS Global Core Infrastructure ETF (CORE)
- CORE provides investors with access to a basket of listed infrastructure companies in developed markets
- CORE is the only unhedged global infrastructure ETF in Australia
- The CORE index applies a volatility screen and is weighted by inverse volatility
- CORE is domiciled in Australia and therefore does not require W8-BEN forms
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