Manager Selection and the #FakeInfra Debate
bfinance insight from:
Director, Private Markets
For institutional investors thinking about LISTED INFRASTRUCTURE, particularly in light of the still-heated “#FakeInfra” debate, three questions are high on the agenda.
One: does listed infrastructure currently offer more attractive valuations or better entry points than unlisted infrastructure? Two: where should it fit within a portfolio? Three: what are the differences between the 30-plus global listed infrastructure funds that are now available to institutional clients – a list which has grown by more than 25% during the past three years?
The points at the heart of “#FakeInfra” are not new: the high correlation between listed infrastructure and listed equity has long been well understood by investors. Many of the arguments are important and relevant. Yet vocal critics may (at the extreme) overlook several fundamental caveats.
Firstly, arguments against investing in listed infrastructure can sometimes be too reliant on the concept of asset class silos and, by extension, what an “infrastructure asset class” should deliver. #FakeSilos can be administratively useful, but they can also be dangerous. Secondly, advocates for unlisted infrastructure may at times overstate the diversification characteristics of private assets, which (as with all private assets) can be exaggerated based on less frequent valuations and artificial resistance to NAV markdowns. These are forms of #FakeDiversification which sophisticated investors seek to look past.
Thirdly, and perhaps most importantly, the criticisms understate certain important realities about the infrastructure investment industry today. Those realities, outlined below, have recently been driving greater appetite for listed infrastructure and REITS among bfinance clients.
What counts as infrastructure?
Critics of listed infrastructure often point to the inclusion of stocks in listed infrastructure portfolios that they do not believe should fall under the “infrastructure” label, such as service companies.
The main listed infrastructure benchmarks differ considerably in terms of breadth and sector exposure. Some funds, particularly the older group, benchmark against the S&P listed infrastructure index, which is quite narrow (75 stocks globally) and utilities-heavy. Other funds use the broader Dow Jones Brookfield index (over 100 stocks), which focuses more on companies’ exposure to infrastructure in terms of underlying revenues, or the even larger FTSE index containing approximately 200 companies worldwide.
The majority of listed infrastructure managers have beaten their chosen benchmarks in recent years, but close scrutiny reveals that much of the outperformance has been the result of exposure to stocks outside of the chosen benchmark: many funds have off-benchmark exposures of 20-30%; for others the figure is as high as 60%. It could be argued, perhaps, that the S&P index has been somewhat easier to beat in recent years than the more diversified Brookfield index. A minority of managers do not use an infrastructure equity benchmark at all but instead opt for an absolute return or inflation + x% target.
Yet the “what counts as infrastructure?” question has also been relevant on the unlisted side of the fence. The last few years have seen unlisted infrastructure managers widening the scope of the sector to include assets that simply would not have fallen within their remit before, such as data storage centres.
We have also seen an increasing emphasis on the “value-added” end of the infrastructure spectrum, which can produce portfolios with higher correlation to equities and more vulnerability to economic cycles than traditional core, especially for GDP-sensitive assets.
Interestingly listed infrastructure funds appear to be more exposed to utilities – a conventional infrastructure sector by anyone’s definition – than many of their unlisted fund counterparts, and many routinely seek to exclude commodity-sensitive stocks.
The balance of listed and unlisted infrastructure– in essence, the question of whether a company that we might define as having an “infrastructure” focus happens to be unlisted or listed – varies hugely based on geographical region.
A focus on unlisted infrastructure will leave global investors somewhat under-exposed to the US, the home of a large number of publicly traded utilities and telecoms companies, and over-exposed to Europe and the UK. Listed infrastructure produces a different pattern: the indices tend to give 40-60% US exposure, with Canada as the second largest country. Among the managers, the average US weighting is currently 38% with a few above 50%. Global listed infrastructure indices and funds also tend to feature significant exposure to Australia – a region where both unlisted and listed infrastructure vehicles have thrived.
Interestingly, for those seeking listed infrastructure managers, these geographical quirks also contribute to substantial differences in team expertise among today’s listed infrastructure teams. Australian funds often feature staff from the unlisted infrastructure sector, while US-based teams are more likely to have strong REITS background. These not only produce distinct cultures but also rather different approaches to issues such as portfolio construction and assessing valuations.
With record levels of fundraising in unlisted infrastructure and high levels of dry powder chasing deals, the illiquidity premium that investors seek through private investments has been greatly eroded. Unlisted infrastructure funds are also deploying investments more slowly, taking up to five years to draw down capital, creating a substantial cash drag which is detracting from returns. Fund-of-funds can take even longer, with managers committing to funds of different vintages.
In such an environment, listed infrastructure can offer a far more rapid means of generating exposure, as well as opportunities for better returns. The daily voting machine of stock markets can provide opportunities to snap up assets at a discount, as seen recently in the UK when infrastructure stocks declined in value following comments by the opposition Labour party around renationalization of assets.
Along with the expense of the assets, investors must also consider the expense of getting into the funds. Listed infrastructure funds are significantly cheaper, at 40-100bps versus a minimum of 100bps on the unlisted side.
Black-and-white verdicts on sectors or strategies always risk missing the mark one way or another. The strategy or manager that complements one investor’s existing portfolio structure, investment mix and risk exposures won’t suit another. The investment climate and industry landscape are continuously evolving.
We urge clients to consider the widest possible universe of options that their structures and governance allow. Investors should periodically review the suitability and attractiveness of listed infrastructure, infrastructure debt, unlisted infrastructure and other real assets (such as agriculture), not to mention the various sub-categories (such as senior versus mezzanine or core-plus versus value-added). Often, we find that fresh examination of today’s strategies, managers and fund types from the bottom up can provide clarity where top-down conceptual frameworks may not.