Global infrastructure: Tangible assets for tangible returns?

Listed infrastructure securities, issued by companies with hard asset-owning business models in heavily regulated industries, can hold up as a buffer in this inflationary environment.

Key points

• In this challenging market backdrop, investment managers need to determine how best to allocate their assets to deliver income for their clients while also protecting against inflationary headwinds.
• We believe that investors should consider global infrastructure securities for their potential to provide downside protection and serve as a reliable hedge against inflation.
• The two fundamental approaches to valuing a company—the cash-flow method and the asset-based method—both favour regulated businesses which own ‘hard assets’ (tangible assets that have intrinsic value) in this market environment.

The cost of a soft drink in 2018 was nearly the same as it was in 2017, and likewise nearly the same as it was in 2016. Prior to 2021, investors had benefitted from a nearly three-decade run of low and stable inflation. In developed markets, particularly the United States and western Europe, prices for goods and services were generally steady overall year after year. Today, however, that paradigm has shifted, and investors are grappling with a new normal of soaring inflation and market volatility. As inflation continues to surge and uncertainty lingers, we believe that investors should consider looking to global infrastructure securities for their potential to provide not only downside protection in this current risk-off environment, but also a reliable hedge against inflation. Regardless of the method used to value a business, we believe the conclusion is the same—the unique features of listed infrastructure companies, which provide essential services for our society, can hold up as a buffer in this inflationary environment.

A shifting paradigm

Currently, the investment community is keeping a watchful eye on the pace of inflation, and for good reason. After 30 years of importing deflation from around the world, one of the most significant imports over the last year for most countries has been inflation. Supply-chain issues, higher commodity prices—further pressured by the conflict in Ukraine—and increasingly hawkish central-bank policy have all served to push inflation into double digits in many developed parts of the world. Emerging markets, which have historically managed with more normal and consistent levels of inflation, are also witnessing these measures surge. This global cost of living increase has created a sense that a recession may be inevitable.

Given the backdrop, where do you go?

In this challenging market backdrop, investment managers need to determine how to best allocate their assets to deliver income for their clients while also protecting against inflationary headwinds. We believe that global infrastructure investments have the characteristics needed to provide just that. Listed infrastructure securities are issued by companies with hard-asset-owning business models in heavily regulated industries. These are typically dividend-paying equities, and as such they generate stable cash flows that are distributed to shareholders in the form of dividends.

Determining the value of a business

Inflationary pressures can create uncertainty for investors, especially in seeking to value their investments. To determine the valuation of an asset or a business, investors essentially use one of two fundamental approaches: the cash-flow method and the asset-based method. With the cash-flow method, a business is evaluated based on the present value of its future cash flows. With the asset-based method, a business is evaluated based on the company’s liabilities versus its assets. We believe that both methods can favour hard-asset-owning regulated businesses.

Cash-flow valuation

When valuing a business on the present value of future cash flows, preferred businesses are able to pass through inflationary pressures, as cash flows adjust in step with inflation. Infrastructure assets are generally regulated, and the revenue is governed by long-term contracts with these built-in inflation pass-through mechanisms. As with most businesses, it is necessary to consider their ability to withstand inflationary pressures, and with infrastructure assets this feature is effectively ensured by these contracts and structures. 

Asset-based valuation

From an asset-based valuation perspective, rent collecting, asset-owning business models, such as pipelines, nursing homes and airports, will all generally see the value of their assets appreciate with inflation, as their rents will typically keep pace with pricing pressures. Assets appreciate while liabilities remain the same, and companies are left with a net asset value (assets minus liabilities) that should keep pace with these pressures. 

Conclusion

Against this challenging market backdrop, we believe investors need to determine how to best allocate assets to deliver income while also protecting against inflationary headwinds. We believe that global infrastructure investments have the characteristics needed to do just that. Listed infrastructure securities are issued by companies with hard-asset-owning business models in heavily regulated industries, with contracts allowing for a pass-through of inflationary pressures. These are typically dividend-paying equities, and as such can generate stable cash flows that similarly keep pace with inflation. Regardless of the valuation method, we believe infrastructure assets stand out as a beacon in the inflationary storm.

Authors

James A Lydotes

Head of equity income and deputy chief investment officer, equity