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Investing in infrastructure in a rising rate environment

Arian Neiron  |  26 Apr 2017Text size  Decrease  Increase  |  

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It is well known that infrastructure securities become more attractive in a low rate environment. However, when interest rates start to rise, it is a common belief that income-producing assets such as bonds and infrastructure securities generally perform poorly.

On the contrary, history has shown that global listed infrastructure securities can perform well after an interest rate hike.

Benefits of investing in infrastructure securities

Recently, investors have been driving demand for infrastructure assets due to their steady and reliable income in a low rate environment.

Investors are particularly attracted to global infrastructure securities due to their bond-like characteristics in low rate environments, hence the label "bond proxy".

However, in March this year the Fed raised interest rates for the third time since the GFC, and while the performance of bonds has since tapered off, global infrastructure securities have seen strong performances.

One reason for this is because rising interest rates are generally an indication of a growing economy. Those infrastructure companies whose revenues are linked to consumer behaviour, such as railway operators and airports, usually benefit from increased demand.

Another reason is infrastructure assets such as utility companies that provide services such as electricity, gas, or water, have earnings that are regulated based on their cost of capital. As the cost of capital rises, so do their revenues.

A well-diversified portfolio of infrastructure securities will therefore include both companies with a hedge against rising interest rates, and companies that will benefit from a rising rate environment.

History shows global infrastructure performs well after US rate increases

Contrary to a "bond proxy" theory, history has demonstrated that a rising rate environment benefits the performance of global infrastructure securities.

When the Fed started its hiking cycle in 2004, global listed infrastructure returned 33.41 per cent in the following year.

Even in the short term, with expected price weakness, performance was 11.27 per cent in the four months following the first 2004 rate hike and 10.89 per cent after the first hike in December 2016.

 

Table 1: Infrastructure Index post the Federal Reserve rate rises

table

Source: Bloomberg, Morningstar, Infrastructure Index is S&P Global Infrastructure Hedged to AUD Index and has been used as it has the longest calculation history. 4 Month period is 1 June 2004 to 30 September 2004 and 1 December 2016 to 31 March 2017. 6 Month period is 1 June 2014 to 30 November 2014. 12 Months period is 1 June 2014 to 31 May 2015. Past performance is not a reliable indicator of future performance.

 

Institutional investors have had access to infrastructure assets for some time so have been able to utilise it as a diversifier to improve portfolio defence and now retail investors can easily trade global infrastructure securities on ASX.

Adding infrastructure to a portfolio

The Sharpe ratio provides a measure of risk-adjusted performance by combining a return measure with a volatility measure to quantify the relationship between the returns and risk.

The chart below shows the impact on returns and Sharpe ratio by adding infrastructure to a typical Australian balanced portfolio as outlined by the MoneySmart Balanced portfolio (Portfolio A).

 


chart

* Portfolio A based on MoneySmart Balanced portfolio
Source: Morningstar Direct, five-year performance 01/04/2012–31/03/2017. Results are calculated monthly and assume immediate reinvestment of all dividends. You cannot invest in an index. Past performance is not a reliable indicator of future performance.
Indices used to approximate investments: Cash - RBA target cash rate; International Bonds - Barclays Global Aggregate Bond Index A$ Hedged; Australian Bonds - Bloomberg AusBond Composite 0+ years; Infrastructure - FTSE Global Core Infrastructure 50/50 Index Hedged AUD; International Equities - MSCI World ex Australia Index; Australian Equities - S&P/ASX 200 Accumulation Index

 

The above results show that compared to Portfolio A, a 5 per cent, 10 per cent, or 15 per cent allocation to global infrastructure over a five-year period would have: increased returns; and increased the Sharpe ratio of the portfolios, delivering a better risk/return trade-off.

Infrastructure assets have also demonstrated lower volatility and a low correlation compared to traditional asset classes.

Accessing global infrastructure on ASX

All investors, be they institutional, high net worth or mum and dad investors, can now access global infrastructure via a simple cost effective trade on ASX with VanEck Vectors FTSE Global Infrastructure (Hedged) ETF (ASX: IFRA).

IFRA tracks the FTSE Developed Core Infrastructure 50/50 Hedged into Australian Dollars Index. It provides investors with access to a portfolio of 150 of the world's largest infrastructure securities in a single trade.

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Arian Neiron is the managing director of VanEck Australia. VanEck is a leading global provider of exchange traded funds (ETFs). This is a financial news article to be used for non-commercial purposes and is not intended to provide personal financial advice to any person.

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