Opportunities in global infrastructure

-- | 25/05/2021 Text size Decrease

Lex Hall: The opportunity for global-listed infrastructure investment over the coming decades is huge. Infrastructure is getting old. The population is growing and global decarbonization goals will require huge spending. With me today to discuss that is Sarah Shaw. She oversees 4D Infrastructure's Global Infrastructure Fund. Sarah, welcome to Morningstar. Sarah Shaw: Thanks very much for having me. Hall: It's a pleasure. You say infrastructure is a means of opportunity for the COVID recovery. What, why and where are you seeing such opportunities? Shaw: Yeah, sure. Look, I think the infrastructure thematic pre-COVID was very, very strong. And I think you mentioned those points, that global need for infrastructure, whether it's driven by replacement spend, whether it's driven by population growth, the emergence of the middle-class or that energy transition. Now, what we've seen is that COVID-19 has not derailed that thematic at all. If anything, it's enhanced it. And what do I mean by that is this much needed infrastructure spend is now being fast tracked as a result of government stimulus programs as they look to actually see their economies recover and come out of the COVID-19 pandemic. With government balance sheets already stretched as a result of the social policies they've put in place, they're going to rely more and more on private sector capital to get that needed infrastructure done, which is great for us as listed infrastructure investors. And then, the final, I guess, the perfect storm comes about because interest rates are lower for longer or anticipated to be lower for longer. Hall: OK. So, we are talking about things like roads and airports and utilities, things like that? Shaw: Absolutely. Look, I think, everything is going to benefit from stimulus and we are seeing road programs, we are seeing utility programs and the big one clearly has been the energy transition or increasing that green energy, sustainable environmental strategies around the world. And a lot of stimulus programs are focusing in on that. So, that's a real boost to utility investment programs. But the other assets that the user pays, the toll roads, the airports, the port, the rail, they are not missing out because any infrastructure investment creates that demand and shifting of goods around the economies and just gets that overall economic activity moving. So, they are all going to benefit. Hall: OK. Just on that, because we all remember the scenes of empty roads and so on during periods of confinement and lockdowns, which is still sort of hanging around in Europe. France is, for example, celebrating the fact that it can have an outdoor meal. Are you as— an infrastructure fund manager, are you worried about further disruptions and things like that? What sort of effect does that have on you? Shaw: Yeah. Absolutely. Look, we've got to remember that infrastructure assets are long dated assets. So, a 12-month disruption or even a two-year disruption, which is definitely what we saw in 2020, it's difficult for that year, and it does have a really direct harsh impact on earnings, because these are largely fixed cost businesses. So, 2020 was pretty ugly for all of those that have a volume link, so the toll roads, the airports, the ports and rail. But when you are looking very long-dated assets, we do anticipate recovery and we think that the market corrected much more than it should have. So, yes, there was a valuation impact, no question, and further disruption, third, fourth, fifth wave of COVID where we see increasing restrictions, that will cause ongoing disruption. But these assets are very resilient. They recover very quickly. They are very long dated. And structure of their concessions or their regulatory models in a lot of cases will correct as well going forward. They may not recover what we've lost, but that's certainly been priced into these assets now and going forward, we'll see that that recovery come through. Hall: I noticed, Sarah, your six-month outperformance was 10 per cent. Is that the recovery that you're…? Shaw: Yeah, it really is. So, I think it's—we are a big advocate of active management within infrastructure. So, just to put this and explain that 10 per cent, there's two very distinct sub-sectors within infrastructure. One is what we call our regulated utilities or our essential services. These were the assets you really wanted to be exposed to in the worst of the COVID pandemic lockdown in mid last year. On the other hand, we have what we call user pay assets, so your toll roads, your airports, your port and your rail, which you mentioned, had a horrible experience during those lockdown periods, because their volumes are directly correlated to GDP and their tariffs are directly correlated to inflation. Now, these are the assets that you want to be active—you're positioned in for the recovery phase. So, when we are reopening economies, when all that pent-up consumption is coming back to the market. So, for us, we actively manage between those two sub-sectors. And sort of in September, October last year when we saw signs that the vaccine was coming or imminent, we reallocated to an overweight to those oversold user pay assets such as airports, ports, rail and road. Hall: There was a slight period of underperformance, I think, over the past two years, perhaps. What do you put that down to, because to me on paper it sounds great for global infrastructure? Sounds like a win-win kind of thing. But what sort of things can lead to poor performance? Shaw: Yeah. Look, it was a really difficult 2020 and a very frustrating 2020 for an infrastructure investor because we are in equity and we were caught up in the March 2020 sell-off, okay? It was an indiscriminate sell-off and we were caught up in that. However, unfortunately, we did not participate in the cyclical market bounce that immediately followed that. And what we saw is that 2020, and this is infrastructure of the asset class and 4D included in that, is that we ended 2020 with the infrastructure indices down about 15 per cent to 20 per cent, whereas the MSCI World ended up 5 per cent. So, in what was a very difficult year, there was a strong recovery in general equities whereas infrastructure underperformed, and that was really not justified because the fundamentals of the asset class did exactly what they should have, and that's give you defensive earnings. And that's something that you have to deal with when you are an equity market investor and we just have to position for the long-term quality and value opportunity and wait for the market to catch up with us, which is what's been happening. Hall: Sure. Okay. We'll look at a few individual stocks in another video, but let's touch on a couple of themes at the moment. The IMF predicts that China will drive economic growth. I think everybody sort of agrees on that by now. How are you capitalizing on that? I noticed that you've got Shenzhen International. What are the names and sectors are you considering there? Shaw: Yeah. So, look, we think the emergence of the middle class in the developing economies wherever they may be, and clearly China is leading that, is an amazing thematic. Now, if you think about it, it's just a general thematic. As your wealth improves and you become sort of into that middle-class segment, how does that change your consumption? It starts with three meals a day, moves to things like I want clean water; I want indoor plumbing; I want electricity and gas for cooking and heating. That's infrastructure. The time once you get that, then you want white goods. I want the TV; I want the fridge. That's logistics change and it's more infrastructure usage. Over time it develops, and you want a scooter, or you want a car. So, you need quality roads to move about on and that creates further economic growth. So, what you can see there is infrastructure is one of the first beneficiaries and a huge driver of the emergence of the middle-class being led by someone like China. Hall: OK. Well, that's very nicely put actually. It's a good way of thinking about it. And the other final thing that we should discuss, Sarah, is what's happening in America. What sort of moves are you making in light of the Biden administration's US$2.25 trillion infrastructure plan? Shaw: Yeah. Look, it sounds fantastic on paper and I've called it internally the pot of gold at the end of the rainbow because I can't really see the investment proposition for us here right now. One of the big things about the US and their infrastructure program is how they are going to pay for it and who is going to pay for it. And to-date, the American government have chosen to want to control that and facilitate that. The one area that we have been investing in for many years, which is more like a state-led program, is the renewable energy or the energy transition movement in the US Now, as I said, that's largely driven at the state level. So, that's where sort of we're really capitalising on that for those programs. Whereas this over $2 trillion program at the moment, I look at where it's going, and I don't see too much of that or where that's going to come into private sector hands. Hall: Sarah Shaw, we will talk about a few individual stocks in a subsequent video. But for now, thank you very much for your insights today. Shaw: Thanks very much for having me.