In this interview, Justin Lannen, a portfolio manager at Macquarie, outlines where the current investment opportunities within the listed infrastructure sector lie. Infrastructure has become an increasingly important asset class.

Listed infrastructure is a good defensive investment in a world plagued by recession, but can also benefit from growth opportunities and capture upside, Justin Lannen, portfolio manager of the CF Macquarie Global Infrastructure Securities Fund, told WealthBriefing in a recent interview. The fund delivered a 12 month performance to 31 July 2010 of 19.41 per cent for the retail class share.

Essential services in monopolistic markets

Infrastructure companies provide essential services and therefore generate good cash flow streams, says Lannen. However, they can also capture upside – as usage and investment increases in booms.

Macquarie’s research based on data from Bloomberg shows that the S&P Global Infrastructure Index in dollars, from the period November 2001 to June 2010, returned 3.6 per cent on average in an up month, compared to 3.3 per cent for the MSCI World TR, and dropped 2.8 per cent on average in a down month, compared to 4 per cent for the MSCI World TR.

These firms benefit from the monopolistic-like nature of the industries they operate in, says Lannen.

“Most of them are natural monopolies – that’s important in a downturn,” he says.

At the moment, the fund is big on toll roads, particularly city-based toll-roads, because, “despite the recession people continue to drive”.

Favourable fundamentals

This sector is a long-term, thematic play, and ties in with the increased popularity of theme-based investing (as opposed to by country, for example). One trend that has been ongoing over the past 25 years or so, and is a boon to the sector, is the privatisation of infrastructure companies. And fiscally distressed governments will speed this process, says Lannen.

Therefore, investing in this asset type must be done with a long-term view, especially as firms are often involved in long-term concessions and contracts with governments.

“Many companies you invest in now will be doing big things in 15-20 years,” says Lannen.

As with all listed assets price fluctuations provide buying and selling opportunities. An example is the panic in May/June over European finances, at which point the fund was selectively buying in Europe.

“We didn’t go and buy every European infrastructure company when European stocks fell though,” he adds.

Where to invest

The first and most important factor is the company’s valuation based on long-term discounted cash flow, says Lannen. The fund uses research from a team of six analysts based in New York and Sydney.

It looks for “quality” infrastructure companies – with assets in areas where there are high barriers to entry, or tariffs and fees that can be applied at or above inflation. An example of this is UK water stocks, says Lannen.

Another key feature is transparent and stable regulation without too much political interference. A recent example of this is the increasing regulation of electricity in Portugal and Greece due to the austerity measures there.

“What was once good regulation is becoming more uncertain,” says Lannen. Consequently, the fund has no holdings there.

Emerging markets represent a challenge and an opportunity, and the fund’s portfolio consists of around 10-15 per cent of these stocks.

However, it can depend on the sector. For example, the Chinese electricity sector has too much government involvement, but the transportation sector is very attractive, says Lannen. The fund is around 10 per cent invested in Chinese transport infrastructure at the moment, and likes toll roads in a country where car buying is on the up. (Chinese car buying overtook that of the US last year.)

At the other end of the spectrum, the fund has no holdings in either Russia or India. Russia is too uncertain, says Lannen, while India presents huge opportunities but making money from it as an investor is hard at the moment.

Brazil is a good bet for infrastructure; it has seen a good economic recovery, has plentiful natural resources, and a growing population. 

The fund owns a sea port and an electricity generation and distribution company there, and says the country performed very well for it last year.

The fund invests in companies with a range of dividend yields, and the average gross dividend yield is just under 4.5 per cent.

Most of the fund’s companies are mature (they already have assets generating cash flows) but also have projects that will deliver growth. This makes it easier to assess the profitability of future developments. A good example of this is oil pipeline infrastructure in the US and Canada, where you have companies with existing networks but which can also deliver growth through new projects, says Lannen.