Allocating to listed infrastructure makes sense for three key reasons, namely valuations, downside protection and secular tailwinds, according to Michelle Butler (pictured), real assets portfolio specialist at Cohen & Steers.
“One reason to allocate to listed infrastructure is valuation. Infrastructure typically trades at a 10% average premium to global equities and today it is actually trading at a 10% average discount,” she said.
“The second reason is downside protection. We see the shift in focus occurring from inflation to growth as the year has progressed. And infrastructure is typically viewed as a defensive asset class.”
“The final factor is secular tailwinds and in particular the one that’s getting the most attention of late — be power demand. That’s a global phenomenon but it’s accentuated in the US where a lot of data centres are.”
Butler’s comments come despite a challenging period for listed infrastructure, which effectively gave back all of its gains from 2022 last year as higher interest rates weighed on performance (see chart).
Its performance this year has been better, although it has continued to lag broader equities due to the hype around AI.
There are good reasons to believe that this is just an aberration, including the fact that the valuation discrepancy with global equities is now higher than it was even during the pandemic when transportation effectively ground to a halt and energy demand collapsed.
There is also the fact that listed infrastructure tends to do better when interest rates have peaked, which is likely the case now, even if expectations of US Fed rate cuts continue to be pushed back.
However, Butler’s views vary depending on which of the four main sub-sectors of listed infrastructure is being discussed, namely transportation, utilities, communication and midstream energy.
She is probably most enthused about midstream energy, where she notes that operators have transformed their business models over the past decade.
She refers to midstream 1.0 in which companies were carrying high leverage, overspending on capex and had very little cash flow, which caused pain when the downturn in the energy markets hit in 2018.
This was followed by midstream 2.0, where capex was still high but companies cut their dividends to shore up their balance sheets.
The current model, midstream 3.0, has seen companies cut their capex and are now “swimming in free cash flow”.
“We see them as a total return compounder and it continues to remain an exciting area,” she added.
Cohen & Steers is also overweight communications, despite the fact that leasing activity has slowed significantly and the fact that out of the four sub-sectors it probably struggles the most when interest rates are high due to the absence of any clawback mechanism.
Butler notes that valuations are really attractive though and expects leasing activity to rise with the rollout of 5G.
“As leasing activity has been subdued, the AFFO (adjusted funds from operations) growth has come down a bit and it’s now in the 4%-5% range, but the expectation is that it will begin to improve and get back to that 7%-8% or even 9% range,” she said.
Regarding utilities, which struggled last year in part due to its status in the eyes of investors as a bond proxy, she notes that Cohen & Steers is currently underweight the sector, although they see attractive opportunities in power demand, particularly from data centres.
She notes that out of the three main sub-sectors within utilities, independent power producers have done the best because of their ability to enter into bilateral contracts with data centres and negotiate their own prices.
Regarding transportation, she notes that Cohen & Steers is overweight ports, particularly in emerging market countries, although they have an underweight to toll roads and airports.