Real assets, or infrastructure plays such as companies that own and operate toll roads or airports, are attractive investments because they provide steady cash flows and are highly resilient in different economic environments, says Darren Spencer, New York-based director, alternative investment consulting at Russell Investments. "Regardless of the general level of economic activity, people still commute to work on a toll road on a daily basis," says Spencer, whose firm manages the $400-million Russell Global Infrastructure Pool.
Although the asset class is relatively young, it is poised to grow dramatically. "The numbers that are required to fund and modernize the infrastructure around the world to support growing economies is a staggering US$57 trillion over the next 15 to 20 years," says Spencer. "It's a huge opportunity set in terms of getting in on the ground floor."
Institutional investors in Canada and Australia have already woken to the opportunity. "They are recognized as the global leaders in institutional infrastructure investing. Australian pension funds were pioneers in the field in the early 1990s when there was a lot of privatization in Australia. Similarly, Canadians were early in realizing the benefits of infrastructure," says Spencer. A 1995 economics graduate of Flinders University in Adelaide, Australia, he has specialized in alternative investments for most of his 20-year career.
The Pension Investment Association of Canada (PIAC) represents 140 pension funds and $1.2 trillion in assets. On average, the infrastructure allocation is 5%. "In some cases, the allocation may go up to 10-15%," says Spencer. "Clearly, this is an important component of institutional portfolios."
Importantly, the sheer scale of future projects means that cash-strapped governments must rely on private capital. "Global governments have limited resources given their fiscal constraints. And it's not just building new infrastructure, but maintaining and modernizing what we already have," says Spencer. Other driving factors are growing global populations, increased urbanization and demands from affluent middle classes in emerging markets. "Private capital will be very important in addressing the challenges."
Real assets like infrastructure offer a measure of portfolio diversification, says Spencer. Based on 10-year forecasts, research by Russell indicates that infrastructure assets have a 0.61 correlation to Canadian equities, 0.14 to Canadian bonds and 0.62 to global equities. "There are significant benefits in terms of reducing the overall portfolio volatility by adding infrastructure," says Spencer.
"What's important is that as investors have had experiences with volatility and low interest rates, they are placing greater emphasis on portfolio diversification," Spencer adds. "Infrastructure can help provide an opportunity to realize your total portfolio objectives while managing overall risk at the portfolio level. In a broadly diversified multi-asset portfolio, this is a key component."
So-called "pure-play" infrastructure assets (which for instance excludes firms that construct highways or airports) have distinctive attributes. Typically, they provide essential services, operate in monopoly-like conditions and have contracts that can last up to 99 years. "They operate in regulated environments and their revenues are linked to inflation or GDP growth. The cash flows of infrastructure assets tend to be extremely resilient."
Another advantage is what Spencer calls the enhanced yield potential versus other instruments. He notes that the S&P Global Infrastructure Index has a running yield of 3.5%, while the S&P/TSX Composite has a yield of 2.9%, and the DEX Canadian Universe Bond Index yields 1.7%. "Effectively, you're getting a 105% premium over Canadian bonds and a 20% premium over Canadian equities. That's extremely attractive in this environment."
Russell Global Infrastructure Pool employs three sub-advisors. About 38% of the portfolio is managed by Sydney-based Colonial First State Asset Management (Australia) Ltd., which relies on growth-at-a-reasonable-price stock selection. Another 38% is overseen by Chicago-based Nuveen Asset Management LLC, which uses a value-based process. The remainder is overseen by New York-based Cohen & Steers Capital Management Inc., which has long specialized in liquid real assets.
Some of the fund's top 10 holdings include utilities such as Enbridge Inc. (ENB), National Grid PLC and Duke Energy Corp. (DUK), and Groupe Eurotunnel SA, which owns and operates the so-called Chunnel that links the United Kingdom and the Continent. Launched in January 2013, the fund returned 20.3% in 2014 compared to 9.9% for the Global Equity category. In the year to date, the fund has returned 9.5% or 1.2% lower than its peer group.
Spencer, who recommends an allocation in infrastructure assets ranging from 5% to 15%, notes that lower volatility and its twin, downside protection, are perhaps the chief reasons for owning them. As of the five years ending March 31, the volatility of the S&P Global Infrastructure Index was 13.2% -- 2.3 percentage points lower than the MSCI World Index.
The other consideration is how the asset class responds in negative equity markets. "Since 2002, listed infrastructure securities have outperformed global equities in 12 of the 17 quarters of negative equity market performance," says Spencer. "So 70% of the time you are getting outperformance."
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