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Invest like the Future Fund

Russel Chesler  |  12 Apr 2019Text size  Decrease  Increase  |  
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For too long, infrastructure and property have been lumped together in the "alternative assets" bucket. Yet, these assets are definitely entering the mainstream. Already, large institutions use them, and more and more investors are catching on to their benefits.

Infrastructure and property assets typically deliver reliable income streams and potential capital growth to investors, as well as portfolio diversification. Recently, demand has increased as investors consider property and infrastructure as substitutes for historically high-yielding Australian equities given the slowing Australian economy and fears of lower yields ahead coupled with the potential winding back of franking credit refunds if Labor wins the federal election on 18 May.

Institutional investors and large superannuation funds have long invested in infrastructure and global property assets. Australia’s single largest investor, the Future Fund, has led the way.

At 31 March 2018, Australia’s sovereign wealth fund was valued at $141 billion. It has returned an impressive 8.5 per cent per annum over the last 10 years, against a target annual benchmark return of 6.7 per cent. Investment returns had added more than $80 billion to the original contributions of $60.5 billion made by government.

A significant 32 per cent of its portfolio is allocated to so-called "alternative assets" such as infrastructure, property and private equity, which has helped to buoy returns and reduce investment risks. That’s because returns on such assets aren’t highly correlated with stock markets. Below is the asset allocation the Future Fund most recently reported. Property and infrastructure are listed on different lines and not bundled with "alternative" assets.

Future Fund asset allocationSource: Future Fund, Portfolio update at 31 December 2018. The above is not a recommendation of an investment strategy and does not constitute personal financial advice for any individual. 

Another large institutional investor, industry superannuation fund Hostplus, treats property and infrastructure as separate asset classes too. AustralianSuper is another big investor in infrastructure assets and property, treating them separately from alternative assets. AustralianSuper has significant holdings in Ausgrid, NSW Ports, Westconnex and Brisbane Airport. Elsewhere around the globe, AustralianSuper holds stakes in Indianan Toll Road, Manchester Airport Group and Vienna Airport, and Anglican Water in the UK.

While the Future Fund, AustraliaSuper and HostPlus have the scale to buy infrastructure and property projects directly, for investors who are not as big, a good proxy is to invest in listed property and infrastructure funds.

Listed infrastructure and property funds are often more diversified as they own more than one asset and also provide greater liquidity. This means investors can buy and sell as required on an exchange, whereas an investor in a direct real estate or infrastructure project must commit to a large capital outlay for an illiquid investment.

Listed infrastructure operators are typically large with little competition and protected by high barriers to entry. Infrastructure represents a range of assets from toll roads, airports, broadcasting towers to railways. Investors can reap income from infrastructure assets that adjusts throughout economic cycles and different interest rate environments, hence its appeal to institutional investors. Such assets aren't highly correlated with the returns of equities so they provide crucial diversification which can protect portfolios' value when equity markets sell off.

For property, Australian real estate investment trusts (REITs) account for just 3 per cent of the world's REIT opportunity. The US, Europe and Asia offer investment opportunities not readily available in Australia.

These asset classes are accessible for small investors and can be used for the same diversification, defensive and income benefits. Yet many Australian investors still consider property and infrastructure, if they consider them at all, as alternative assets, and not mainstream asset classes. As a result, they may be underrepresented in most retail portfolios and investors are likely missing out on their potential benefits.

Defence when you need it

With rising risks around the economic cycle, infrastructure and property provide a hedge against an equity market downturn. They have strong defensive qualities as they achieve a high proportion of their returns from income rather than capital.

Below we illustrate that infrastructure and property are correlated to asset classes in most Australians' portfolios using the standard market benchmarks as a proxy for each asset class. The FTSE Developed Core Infrastructure 50/50 Index Hedged into AUD has become the global infrastructure benchmark used by industry participants including asset consultants and asset managers. The chart below shows that infrastructure has been among the best performing asset classes since inception of this benchmark on 1 January 2010 while also being lowly correlated with traditional asset classes that dominate Australian portfolios. These include: Australian equities; Australian listed property; Australian bonds and cash; and unhedged exposures to international equities.

Most Australian investors with global bonds in their portfolio seek a hedged exposure to limit the impact of currency movements on income and the same is true of the standard international (ex-Australia) property index, the FTSE EPRA Nareit Developed ex Australia Rental Index AUD Hedged.

Risk and reward of asset classes since inception of FTSE infrastructure benchmark

Source: Morningstar Direct, All returns in Australian dollars. Risk-reward 1 January 2010 – 31 March 2019. 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: Cash – RBA target cash rate, International Bonds – Barclays Global Aggregate Bond Index A$ Hedged; Australian Bonds – Bloomberg AusBond Composite 0+ years; Global Infrastructure – FTSE Developed Core Infrastructure 50/50 Index Hedged into AUD; Australian Property – S&P/ASX 200 A-REIT, International Equities – MSCI World ex Australia Index; Australian Equities – S&P/ASX 200; International Property - FTSE EPRA Nareit Developed ex Australia Rental Index AUD Hedged

Below a correlation of 1.0 means the asset values move together while a score of -1.0 means they move in opposite directions. Anything below 0.5 could be considered a low correlation. 

Correlation of asset classes

Correlation of asset classes

Source Morningstar Direct, All returns in Australian dollars.  Correlation: 1 January 2010 to 31 March 2019. 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: Cash – RBA target cash rate, International Bonds – Barclays Global Aggregate Bond Index A$ Hedged; Australian Bonds – Bloomberg AusBond Composite 0+ years; Global Infrastructure – FTSE Developed Core Infrastructure 50/50 Index Hedged into AUD; Australian Property – S&P/ASX 200 A-REIT, International Equities – MSCI World ex Australia Index; Australian Equities – S&P/ASX 200; International Property - FTSE EPRA Nareit Developed ex Australia Rental Index AUD Hedged 

Accessing property and infrastructure is now easy

ETFs have opened up infrastructure and property making them accessible to all types of investors and no longer just institutions like the Future Fund, HostPlus or AustralianSuper. Because ETFs are traded on the ASX, investors can easily buy and sell in amounts that suit their individual investment needs.

is the director of investments at VanEck Australia.

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