Investing in essential infrastructure




Investing in infrastructure can deliver downside protection, inflation protection and diversification. Tim Humphreys, Head of Global Listed Infrastructure at Ausbil Investment Management, discusses the asset class and opportunities in the short and medium term.

Paul Sanger: Hi. I'm Paul Sanger from the Finance News Network, and today we're interviewing Tim Humphreys, who is the Portfolio Manager of Ausbil's Global Essential Infrastructure Fund. Tim, welcome to the network.

Tim Humphreys: Thanks very much, Paul. Great to be here.

Paul Sanger: Tim, your fund looks at global infrastructure opportunities. Where do the current constituents of your fund mainly come from geographically and why?

Tim Humphreys: Yeah. The fund is 25 to 45 stocks, currently around about 30 stocks, of essential infrastructure companies. So, we have a universe of about 108 companies from all over the world, but primarily focused on the developed markets. We look at companies such as utilities, such as pipelines, toll roads, airports, because these are the companies that we think best deliver the characteristics of infrastructure that people expect. So, things such as downside protection, inflation protection, low correlations to other asset classes, bringing in diversification benefits. So, these are the characteristics that we're trying to deliver. And in terms of the geographic split, primarily in the developed markets, so about half of the portfolio is in North America, then about another 40 per cent is in Western Europe and the UK, and then 10 is based in Australia. And we like to focus on the developed markets because we think that reduces risk. Obviously, there's a lot of opportunity in the emerging markets, but that can also introduce additional risk, such as regulatory risk, political risk, and currency risk. So, for us, the primary focus is on the developed markets.

Paul Sanger: And what mix of listed and unlisted assets does the fund currently have? And, again, why is that?

Tim Humphreys: Yeah. We are fully listed, so 100 per cent of the portfolio is invested into listed infrastructure companies. And it's important to understand that a lot of the assets of infrastructure are held both by listed companies and also unlisted pension funds and superannuation funds as well. So, the M7 toll road, for example, is part-owned by Transurban (ASX:TCL) and part-owned by some of the superannuation funds. So, very often the assets are very similar on the listed and the unlisted side. But the benefits of being listed are first of all, liquidity. So, we can get in and out of a company in a day if something changes, we can sell our shares in a day. And that's a really good risk reduction tool that we have. We also think that diversification is an important factor, and the listed market allows you to have a very well-diversified portfolio. The listed market also typically has lower debt levels than the unlisted funds have as well. And we think that, again, is a good risk mitigator. So, we think there are a lot of benefits to being in a listed portfolio that benefit our shareholders.

Paul Sanger: And, Tim, what screening process criteria do you apply to potential constituents?

Tim Humphreys: Yeah. Our process is all about screening. There's only currently about 108 companies worldwide that fit our definition of essential infrastructure. So, we're always looking to screen out companies because that means that the pool we're left with really does express and distil down those characteristics that we think investors want. So, we look at things like an ESG screen, so excluding out controversial activities and companies that have too much thermal coal. We're also looking at balance sheets, excluding companies that have too much debt in our opinion. Also companies that are too small and don't have sufficient liquidity.

So, when we look at the pool that we're left with, those 108 companies just focus on essential infrastructure. That really does mean that we're defining the boundaries of essential infrastructure. We're creating the right pool to fish in to create the portfolio from. And it also means that those companies we know extremely well. So, we just spend all of our time focusing on those 108 companies to give ourselves an information advantage over the rest of the market, and we think that's a really good opportunity to deliver performance.

Paul Sanger: Tim, the fund runs a high conviction and concentrated portfolio. How volatile have the returns been to date?

Tim Humphreys: Yeah. It's interesting. Over the last few years, clearly we've had COVID come through, and that increased volatility significantly. We saw some of the share prices fall significantly during the COVID crash in March 2020. But, importantly for us, the underlying cash flows that these companies deliver has been very stable and has been in fact growing since COVID. So, when we see the cash flow stable or growing for the underlying companies, but the share prices fall materially, that for us is a really good opportunity to use that volatility and to reallocate the portfolio.

So, a really good example of this was Sydney Airport (ASX:SYD) back in 2020. Share price fell by half because of COVID and there was no traffic going through the airport, but our long-term valuation only moved down by about 10 per cent. So, when we saw the share price down 50 per cent, our valuation down 10 per cent, we jumped on that opportunity and made a really good return for our investors because ultimately Sydney Airport was acquired by the superannuation fund. So, a really good example of how we can use that volatility to generate value.

Paul Sanger: And given the current state of the economy, both globally and locally, how does rising inflation and the rising interest rate environment impact the fund and the investing criteria?

Tim Humphreys: Well, inflation is very good for essential infrastructure because lots of companies have effective mechanisms through which they can pass on inflation. And for us in our portfolio, around about 97 per cent of the portfolio has an effective means to pass through inflation. So, it might be a toll road, for example, that is allowed to increase tolls at the previous year's inflation in that country. Or it might be utilities, whereby they're allowed to increase their bills to the customers in line with inflation the previous year in that country. So, very explicit and highly implicit ways through which inflation can be passed through. And this will turn up in the revenue lines of the companies over the next couple of years.

But in terms of interest rates, we see the main impact being on the valuation. These are very long-term assets, and rising interest rates can reduce the valuations for long-term assets. So, at the moment, we're in a situation where the rising interest rates has hit share prices, the company's share prices have suffered, but the long-term prospects, because of the lagged effect of inflation, have not yet fed through. We see that as a really good opportunity for the fund at the moment.

Paul Sanger: What specific types of infrastructure do you see providing the greatest opportunity in the short and medium term?

Tim Humphreys: Well, at the moment, AI is obviously the hot topic, but we think close behind that is the energy transition, you know, the switching of coal, particularly, generation for renewable, but also the associated investment that needs to be done on the electricity transmission grids. So, just over about 50 per cent of the portfolio is currently facing the energy transition through renewable energy companies, through electricity transition grids and through utilities, particularly in North America, that are closing down their coal generation and also replacing it with renewable energy generation. So, the energy transition is a medium- to longer-term opportunity.

In the short term, we're seeing really good opportunities in the transportation sector, so toll roads and airports, whereby the traffic is now up to pre COVID levels. So, back to where it was. But the share prices are significantly lower than they were in 2019. So, still a really good opportunity there. And then also in some of the longer-dated assets, such as the mobile phone towers, we think there's a really good opportunity there because these are companies where the share prices have been hit by the rising interest rates, the longer-dated nature. But looking at the fundamental value and the cashflow that these companies are going to generate, we think there's a really good opportunity in the mobile phone tower space as well.

Paul Sanger: And what investment time horizon does the fund generally sort of target?

Tim Humphreys: Well, infrastructure should be seen as a long-term asset class. The assets are very long-term in their nature. The cashflow is very secure over the long-term. So, we think a minimum of five years should be viewed as a holding period for infrastructure, but really it should be held for many years, but five years should be seen as the minimum holding period in our view.

Paul Sanger: And, to finish up, what pipeline in terms of opportunities can we see coming over the next year or two?

Tim Humphreys: Yeah. Infrastructure as an asset class is really growing. It's very well known in Australia, but the infrastructure story is just sort of getting out to people in North America and Europe. So, it's a really exciting pathway for the asset class going forward. And when we look at essential infrastructure, we believe that essential infrastructure is the fastest-growing part of infrastructure. So, for us, it's really exciting because companies are selling off some non infrastructure assets and moving into our universe. We're also seeing companies demerge or list assets into new companies. So, overall, our universe of companies is growing, and that's sort of at odds with what the view here is in Australia because, over the past few years, we've seen a lot of the infrastructure companies be acquired by the superannuation fund. So, whilst the universe is reduced in Australia, it's growing overseas. And that gives investors, in our view, a really good opportunity to get into the infrastructure theme and benefit from those infrastructure characteristics, downside protection, inflation protection, good dividend yield, and also diversification benefits because infrastructure as a theme is only going to grow over the next 5 or 10 years. And we think infrastructure, and listed infrastructure in particular, will become a standalone allocation to a lot of investors' portfolios.

Paul Sanger: Tim Humphreys, many thanks for your time.

Tim Humphreys: Absolute pleasure. Thank you.

Paul Sanger: Thank you.



Name Paul Sanger