Investing in Infrastructure Q&A

Shane Hurst: The focus of our global infrastructure strategy is very much on those very stable, essential service assets. These are the assets that are able to deliver stable cash flows, stable dividends and stable returns with low risk through the cycle. The focus itself in that definition is on regulated utilities: that your water utilities, gas, your electric utilities, generating a regulated return, as well as a regulated asset base, but also transport infrastructure companies, so these are your GDP sensitive road, rail and airport assets. So our our focus is such that we are able to exclude volatile cash flow assets and really concentrate on our definition, which delivers us very stable, risk adjusted returns to equity.
 

Shane Hurst: Yeah, so the correction happened in the September period for a number of reasons. I think, firstly, we saw the unfunded tax package get announced in the UK and that obviously caused jitters around the globe as bond yields increased and and there were there were big concerns over sovereigns. I think the other thing clearly was the Federal Reserve and central banks continue to get very hawkish on inflation, and that led to a large rise in real rates around the world. Interestingly, the implications or the read through for infrastructure, which we don't think is correct but really was firstly that would impact interest expense on a short term basis. The other implication was higher bond yields and high real rates would flow through to lower valuations. Now the reality is a little bit different. The reality for infrastructure and utility companies is they have hedging, which is out greater than ten years, so an increase in interest rates has very little impact on interest expense, shorter term. The other the other point to to make is rising inflation, rising GDP or changes in GDP and changing bond yields actually get passed through in the in the case of infrastructure and utility assets. So net net over time that that should be neutral. In fact, what the period allowed us to to do was move the portfolio into opportunities where we saw them. They may be in the UK, they may be in the in the in the US and really add to the portfolio in the October period.
 

Shane Hurst: So in terms of the impact to infrastructure and utilities from a global recession, it's really felt mostly through our transport infrastructure names. These are your airports, your roads, your rail and port assets. Essentially what happens in a recessionary type outcome is you see volatile traffic. And as a result of that, you do see underperform itself. Of the individual assets, whether that be airport, road or rail assets and the underperformance of underlying stocks. Now, we have been asset allocating away from these assets very much on a bottom up basis. We see substantial value in other areas. These would include your regulated utilities, which regardless of what happens in the business cycle, these are essential service assets with with regulated assets, regulated returns. And importantly, they're underpinned by very strong thematics such as decarbonization.
 

Shane Hurst: Absolutely. I mean, the the scope and the size of the opportunity is immense. And we're talking, you know, $100 trillion over the next 30 years likely to be spent to get the world towards a net zero outcome in 30 years. Where do, where do we access that? We access that through our strategy, through firstly, through our regulated utilities that spend capital to harden their grids.They roll out renewables. They also facilitate hydrogen and carbon capture. We are also able to to capture that through our strategy in our contracted renewables. They are rolling out wind and solar assets for the long term contracted assets with very little to none in terms of technology risk. Finally, we are able to access it through our pipeline assets. And our pipeline assets are facilitating the move towards net zero through hydrogen movement and carbon capture and and and storage. If you think about the policy side and it is really crucial for renewables, there's been a number of different initiatives globally and regionally in terms of policy support, whether it be the Fit for 55 or Repower EU in Europe, which is substantially accelerated the growth of renewables in in the region. More recently, the US Inflation Reduction Act has has been a real game changer for the US as it incentivises not only wind and solar but also assets like nuclear assets, i.e. incentivised hydrogen production and also it it really helps to firm up the production, manufacturing of a lot of the renewables kit or or equipment in the US, taking it away from regions like China and other places in Asia. Importantly, it's not just restricted to to renewables. We are able to actually access that theme through more traditional asset classes and these tend to be your pipelines where they are able to adjust their asset bases. For example, in Italy, there's one company where we are seeing floating storage being part of their capital plans. Similarly in the US, exporting LNG is crucial to the to their business going forward and certainly will benefit from the move towards net zero and gas being that transition fuel.
 

Shane Hurst: Well, it's important to note that, you know, for our portfolio and our strategies, we have a 90% plus pass through of of inflation. So why, why does that happen. Well think about infrastructure assets and these are your transport infrastructure assets, they adjust their tolls, their tariffs, their rates by inflation through a cycle. It's a straight pass through. When you think about our utility names, they actually adjust it through their returns, adjust it through their asset base. So you get a very unique hedge of inflation through infrastructure and and utilities. So when you so when you when you think about it in a rising inflationary type environment, you actually get a net neutral impact to the portfolio. And sometimes, in fact, it can be positive.
 

Shane Hurst: So in a low inflationary environment, you know, and we really have to go back no more than three or four years to see that type of environment. You do actually get greater headroom for the utility companies as an example. And the reason you do is obviously as a as a proportion of their bill, you don't have that energy cost. You don't have that higher inflation pass through. So as a result of that, you actually get greater capital spend for a number of our companies. And with such substantial themes underpinning the growth of the asset class, whether it be decarbonization, whether it be the thirst for data leading to communication, infrastructure growth or in fact, demographic change. You know, it it really is a it's a very strong environment for infrastructure and and utilities from a falling inflation type environment.
 

Shane Hurst: So, absolutely, I mean, infrastructure and utilities are unique. So so let's think about the asset class. The asset class is able to pass through inflation. We've talked about that. The asset class is in fact, able to adjust for rising levels and falling levels of GDP and pass through changes in bond yields. And so so what does that actually mean for dividend yields? What it means is for businesses that aren't leveraged to the business cycle and are in fact essential service businesses, cash flows are very stable through the cycle. Dividends are very stable through the cycle. How do we think about it? Look, we we spend a lot of time thinking about the the volatility of cash flows and the volatility of those dividends. What does that mean? What we use it a proprietary yield quality measure that looks at coverage, looks at growth, looks at the absolute size of the dividend yield. The size of our team is one of the largest in the market. And so what that means is we are able to spend a lot of time running scenario analysis and sensitivity analysis such that the impact from different environments doesn't materially impact our dividend yields. And just to give you an example, in our forecast dividend yield going forward, just to give you an example, if we go back to the COVID period, which is probably the most extreme period we've seen in recent years, there was very, very minimal impairment of our dividend yield going forward of the strategy. Again, because we were able to identify issues early and invest in those assets that really delivered a very stable cash flows, stable returns and importantly stable dividends and growing dividends going forward.
 

Shane Hurst: Yes. So, again, very important to note. You know, a rising rate environment is caused by a number of things. Is it caused by inflation? Maybe, if it is caused by inflation can that inflation be passed through? Absolutely. Is it caused by stronger growth as as it as it was maybe earlier last year in 2021? Yes. Okay. It was again, that is passed through through greater growth greater growth through these assets. So rising rates in and of itself don't impact infrastructure utilities because they get passed through, whether it be in returns, whether it be in in other mechanisms, such as tolling mechanisms to the ultimate consumer. Short term, and there's no doubt short term rising bond yields in equity markets cause that sticker shock that we saw in September. But as we saw in October, what that's allowed us to do is position the portfolio going forward. And importantly, and this is crucial whether a specialist infrastructure investor really understands the implications for the underlying assets, what does that mean is what does that mean? Is that really we build stronger portfolios going forward with more stable cash flows and take advantage of those volatile outcomes to deliver those risk adjusted returns going forward.
 

Shane Hurst: Absolutely. The case for infrastructure is still very attractive. And there's a number of reasons why. Firstly, as well as as we've talked about a number of times with our clients, you do get a very stable pass through inflation. These are essential service assets and certainly they tend to be uncorrelated with other assets in the market. Secondly, there are very strong themes underpinning their assets. These assets, whether it's the move towards net zero, whether it's demographic change or communication infrastructure growth driven by the thirst for data, you have very, very strong themes underpinning the growth of global infrastructure. Third is the valuation argument. Certainly these companies are trading pretty at pretty similar multiples as they have over the last ten years. But the outlook for these companies is far improved from a number of the themes we've talked about. So valuation wise, also attractive. And then finally, there's a lot of unlisted money, a lot of unlisted capital coming to listed markets and and paying substantial premiums for these assets, 30% odd type premiums and they're acquiring whole assets, part assets or entire assets with this substantial wall of capital sitting out there. And when I say wall of capital, there's essentially 300 billion USD of capital sitting out there waiting to invest in assets. What does that mean for listed markets? Well, it really proves that the valuation case for listed infrastructure, because these these unlisted parties are coming into listed markets and paying those large premiums for these assets.