The Investment Case for Infrastructure

Key takeaways

As a proven inflation-hedge strategy, and with inflation and rates that are expected to be “higher for longer”, the infrastructure asset class has attractive characteristics for the current economic environment.

However, this is only true for the companies that have a good long-term debt situation, as debt refinancing and funding strategies in the current context will separate the winners from the losers.

As an added benefit, infrastructure assets are linked to 72% of the Sustainable Development Goals (SDGs) targets, so we may as well build a more sustainable future while shielding ourselves from inflation.¹

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Introduction

Remember when some pundits were talking about inflation being “transitory” a couple years back? So much for that! The overwhelming consensus is now that high(er) structural inflation is here to stay, along with high(er) rates. The immediate consequence of this situation is that stocks and bonds are more correlated, which dampens the traditional “shock absorber” role that bonds historically played in asset allocation.

At the same time, global leaders have collectively committed to build a safer, cleaner, and fairer world for our children; an ambition that will require levels of investments previously unheard of.

This situation is where real assets – and infrastructure in particular – shine and maximising exposure for asset owners will be beneficial. The good news is that more and more options are becoming available to investors, including retail, to participate in this asset class. As shown below, assets under management (AUM) for both private and listed infrastructure strategies are on the rise, with the listed segment growing slightly faster.²

AUM ($USD Bn) from Asset Managers for both listed and private infrastructure strategies

Is Infrastructure an Inflation Hedge?

In today’s economic climate, infrastructure assets’ ability to act as a shield against inflation adds to its allure. This characteristic is because many infrastructure subsectors are the quasi-exclusive providers of their services within a certain region, which means they have strong pricing power given the inelastic demand for their services. When prices go up, they can simply pass on those increases to consumers through higher tariffs. As a result, they maintain steady revenue and profit margins during periods of rising inflation, safeguarding the returns for investors. Furthermore, most of these inflation-adjustment provisions are built-in either through regulation or concession agreements or contracts. On average, about 70% of revenues generated by infrastructure assets have some sort of inflation protection, but its level varies widely across subsectors, as shown below.³

Infrastructure as an inflation shield - degree of inflation protection by sub-sectors

Thanks to this fairly unique feature, infrastructure investments tend to perform much better than other asset classes under higher-than-normal inflation environments. The chart below shows that the annualised performance of infrastructure investments during times of above-average inflation was more than double the returns for US Equities during the same periods.⁴

Obviously, blindly investing in the asset class does not guarantee a hedge to inflation. For example, a higher rate environment disproportionately affects the renewables sector as the majority of the infrastructure project costs are front-loaded due to the fact that the “fuel” is free (wind, sun, etc.). Even though utilities have stable long-term cash flows which allows them to be highly levered with long-term debt, the recent jump in long-term interest rates is changing the economics of greenfield projects. With interest rates cost forecasted to occupy a much larger proportion of the expenses than predicted, some renewable energy developers and operators have delayed infrastructure projects and asked to re-negotiate previously agreed power purchase agreements (PPAs).⁵ It is worth noting that this is essentially the first time the renewable energy sector has faced a high interest rate environment. This situation should serve as a teachable moment to structure deals that account for inflation and higher rates.

Consequently, the renewable energy troubles should therefore be, shall we say, “transitory”. Looking ahead, there is no scenario in which renewable energy is not a key sustainable infrastructure subsector where investment opportunities will abound.

According to the International Energy Agency (IEA), annual clean energy investment worldwide will need to more than triple to around $USD 4 trillion to reach Net Zero emissions by 2050, the majority of which falls in the infrastructure bucket.⁶

Required infrastructure investments in USD Trillions by 2035

Pervasive Impact of Infrastructure on the SDGs

Sustainability-minded investors will probably want to focus on the “Sustainable” part of the infrastructure asset class. One may think it would be a small subset of the larger pie, but they would be wrong. Using the Sustainable Development Goals (SDGs) as the reference framework, researchers have found that infrastructure either directly or indirectly influence all 17 SDGs, including 121 of the 169 targets (72%).⁷ For 15 of the 17 SDGs, more than half of the targets are influenced by infrastructure, including for 5 of the 17 SDGs (SDGs 3, 6, 7, 9, and 11) for which all the targets are influenced by infrastructure.⁸

No SDGs without Infrastructure

Number of SDG goals that are directly, or indirectly influenced by infrastructure assets

SDGs	Direct Influence	Indirect Influence
Goal 1: No Poverty	1/7	3/7
Goal 2: Zero Hunger	1/8	6/8
Goal 3: Good Health and Well-being	1/13	12/13
Goal 4: Quality Education	0/10	8/10
Goal 5: Gender Equality	1/9	5/9
Goal 6: Clean Water and Sanitation	6/8	2/8
Goal 7: Affordable and Clean Energy	4/5	1/5
Goal 8: Decent Work and Economic Growth	0/12	7/12
Goal 9: Industry, Innovation and Infrastructure	4/8	4/8
Goal 10: Reduced Inequalities	0/10	6/10
Goal 11: Sustainable Cities and Communities	5/10	5/10
Goal 12: Responsible Consumption and Production	4/11	4/11
Goal 13: Climate Action	1/4	2/4
Goal 14: Life below Water	2/10	4/10
Goal 15: Life on Land	0/12	6/12
Goal 16: Peace, Justice and Strong Institutions	0/12	7/12
Goal 17: Partnership for the Goals	1/18	7/18

Bottom Line

The Thacker et al paper also argues that infrastructure assets beyond the usual suspects (renewables, water, passenger rail, health care, education) play an important role in achieving the SDGs. For example, transportation infrastructure assets such as ports and airports are crucial for the economic development and betterment of millions of people around the world. And digital assets such as towers and data centres allow for better information and communication which are known social and economic equalisers.

In conclusion, recognizing the diverse range of infrastructure assets, including transportation and digital infrastructure, as vital contributors to the SDGs underscores the interconnectedness of global development efforts and the need for a holistic approach to achieving these goals.

This Featured Article has been produced by Sustainable Market Strategies. Rize ETF Ltd make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability or suitability of the information contained in this article.

References

International Institute for Sustainable Development, “SDG Knowledge Weekly: Cities and Infrastructure”, 11 April 2019. Available at: https://sdg.iisd.org/commentary/policy-briefs/sdg-knowledge-weekly-cities-and-infrastructure/

Chart: Sustainable Market Strategies 2023; Source: GLIO and Preqin 2023. Available at: www.sustainablemarketstrategies.com

Chart: Sustainable Market Strategies 2023; Source: Colonial First State Global Asset Management 2023. Available at: www.sustainablemarketstrategies.com

Chart: Sustainable Market Strategies 2023; Source: Macrobond, Cambridges Associates 2023. Available at: www.sustainablemarketstrategies.com
The annualised performance shown relates to the period between 30 September 2003 to 30 September 2023. Infrastructure: The performance shown is the actual past performance of the FTSE Developed Core Infrastructure Index. US Equities: The performance shown is the actual past performance of the MSCI USA Index. Global Equities: The performance shown is the actual past performance of the MSCI World Index. 10-year US Treasuries: The performance shown is the actual past performance of the S&P U.S. Treasury Bond Current 10-Year Index. Global Bonds: The performance shown is the actual past performance of the Barclays Global Aggregate Bond Index. The performance data shown does not reflect transaction costs and management fees incurred or charged by financial products. Please note that the value of an investment and any income taken from it is not guaranteed and can go down as well as up. You may not get back the amount you originally invested. If your investment currency is different to USD, then the return you will get from the investment may increase or decrease as a result of currency fluctuations between USD and your investment currency.

Reuters, “Cost crunch prompts mass rethink of US offshore wind contracts”, September 2023. Available at: https://www.reuters.com/business/energy/cost-crunch-prompts-mass-rethink-us-offshore-wind-contracts-2023-09-13/

IEA, “Net Zero by 2050”, 2023. Available at: https://www.iea.org/reports/net-zero-by-2050

Table: Sustainable Market Strategies; Source: Thacker, S., Adshead, D., Fay, M. et al. “Infrastructure for sustainable development”. Available at: https://www.nature.com/articles/s41893-019-0256-8

Ibid.