Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 141

Infrastructure risk factors in the current macro environment

Over the past six months, we have seen an environment of lower growth in China, uncertainty in equity markets, continuing downward pressure on the prices of resources, the start of a Federal Reserve (‘Fed’) tightening cycle and signs of a potential high yield credit squeeze and repricing. These are all cause for us to reflect on our approach to risk.

At Magellan, we seek to take a holistic view of infrastructure which considers various risk factors in whether an asset meets our definition of infrastructure and standards for investing. The stability of earnings is determined by more than an asset’s competitive position; there is a range of other risk factors which will influence earnings streams.

We assess many risk factors, but the past few months have highlighted a few worth considering:

  • Sovereign risk: we avoid countries where political decisions can easily be made which undermine the contractual position or potential earnings of a company.
  • Additionally, we only invest in countries where the judicial system and law are sound so that contractual positions can be enforced in need.
  • Regulatory risk: we avoid jurisdictions where regulatory processes are opaque or inconsistently applied.
  • Commodity price risk: we do not invest in businesses which are materially reliant on the price of the product which they transport e.g. many pipeline businesses and Master Limited Partnerships (MLPs) in the United States are excluded from our universe for this reason.
  • Leverage risk: we avoid businesses with high leverage or where their ability to service their debt is tight relative to their earnings.

Interest rates, debt and leverage

We expect global monetary conditions to experience further tightening over the medium term and, consequently, for longer tenor rates to increase.

There are two key areas to focus on when considering interest rates: the impact on the businesses in which we invest, and the impact on valuations and on debt and equity markets.

1. Impact on the businesses in which we invest

We are confident that the underlying businesses in which we invest are in good shape, have strong capital management and are well-placed to manage successfully any inevitable increases in base lending rates. Strong capital management is critical and means these businesses largely have:

  • Solid investment grade credit ratings, which are important to ensure they have access to multiple credit markets at all times regardless of credit cycles.
  • Strong credit metrics i.e. they have a level of leverage that underlying earnings can comfortably support, and have strong debt service ratios. We estimate that, on average, the companies in our investment portfolio generate free cash to service debt of more than four times their annual debt service, which we view as a strong buffer particularly given the stability of the underlying earnings.
  • Access to various debt markets (e.g. US, Europe, Canada, Australia), meaning they are not reliant on any single market.
  • Improved credit ratings over time as their earnings and credit metrics have improved.
  • Available liquidity and credit facilities to fund expansion or liquidity requirements.
  • Lengthened and de-risked their debt maturity profiles so that the average repayment term dates are typically 8 to 10 years out, and repayments of debt in any single year is not excessive relative to the total debt burden.
  • Managed interest rate exposure by undertaking material interest rate hedging or issuing fixed rate bonds to ensure earnings remain stable over the longer term.
  • Reduced the cost of their borrowings throughout 2010 to 2015 by taking advantage of cheaper credit (lower base rates and margins), but also have further opportunity to reduce debt costs over the medium term by replacing more expensive ‘old’ debt which is becoming due for repayment over the next few years.

It is important to note this last point. While interest rates are very likely to increase in the United States in the next few years, the average cost of debt of the US stocks in our funds is likely to continue to fall as maturing debt is replaced with cheaper debt. As an illustration, the following graph shows consensus forecasts for the average cost of debt for Kansas-based power utility, Westar Energy Inc, showing the average cost of debt declining until 2018.

So overall, we remain confident that these businesses are well-placed to continue to meet our investment expectations over the medium term and through a period of rising rates.

2. Impact on valuations and on equity markets

An increase in interest rates can be expected to lead to a higher cost of debt and an increase in long term discount rates. Our forecasts and valuations take these factors into account in our investment analysis. However, the history of financial markets leads us to expect increasing uncertainty as a consequence of a rising rate environment.

Stocks which are regarded as ‘defensive’, including infrastructure and utilities, are often subject to negative sentiment during periods of interest rate increases as investors switch to higher growth sectors. However, it is our experience that, provided the businesses have solid fundamentals, their stock prices can be expected to revert to trend reflecting their underlying earnings profiles.

Notwithstanding equity market volatility we expect that underlying earnings of infrastructure and utilities companies in our defined investable universe should continue to be robust and reflect solid growth.

Ultimately the value of the companies in our investment portfolio reflects the future cash flows they are expected to generate and the risks associated with those cash flows. Magellan believes that, at the current time, investment markets are not pricing assets at the prevailing interest rate levels but rather, are pricing in a higher, more ‘normal’ level of interest rates in assessing the risks associated with future cash flows. This means that if interest rates increase over the medium term we can expect the impact on asset prices to be somewhat muted because investors have already allowed for some level of increase.

 

Gerald Stack is Chairman of the Investment Committee and Head of Investments at Magellan Financial Group and Portfolio Manager of the Magellan Infrastructure Fund. He has extensive experience in the management of listed and unlisted debt, equity and hybrid assets on a global basis.

This material has been prepared by Magellan Asset Management Limited for general information purposes only and must not be construed as investment advice. It does not take into account your investment objectives, financial situation or particular needs.

 

  •   4 February 2016
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

Renewable energy investment: gloom or boom?

8 benefits of listed over unlisted infrastructure

Summer Series Guest Editor, Greg Paramor AO

banner

Most viewed in recent weeks

Why spending more in early retirement can improve lifetime income

Conventional wisdom encourages retirees to preserve superannuation. But if those likely to qualify for the Age Pension later in life spend a little more today, it may deliver higher lifetime income and a more stable retirement.

Will you run out of money in retirement?

Fear of running out has become a defining retirement anxiety. Why do some retirees die with substantial wealth while others deplete their nest egg? Evidence suggests the answer is more complicated than we think. 

The investment that sidesteps the new tax traps

Tax rules have changed, but many investors are still using yesterday’s strategies. Insurance bonds may offer advantages for those seeking greater control, tax efficiency and certainty about their wealth.

Testamentary trusts have secured the CGT exemption

Treasury’s latest CGT reform draft delivers a win for testamentary trusts and deceased estates, exempting estate-derived gains from the 30% floor. However, questions on death and divorce rollovers remain unresolved.

Meg on SMSFs: What do we think about reversionary pensions these days?

Reversionary pensions have long been a staple of SMSF estate planning, but are they still the best option? Meg Heffron revisits a once-clear favourite and asks whether changing super rules have shifted the balance.

How does the 4% rule stack up?

The 4% rule has long been retirement's gold standard. But after a difficult period for investors, fresh analysis suggests a more conservative approach may significantly improve the chances of making savings last.

Latest Updates

Planning

Testamentary trusts survived the trust tax. The drafting battle has just begun.

The fight over testamentary trusts looked settled. Then the draft legislation arrived. Hidden in a technical detail is a question that could force many families to rethink wills they thought were already future-proof.

Investment strategies

The new capital gains tax trap for your portfolio

Investors have long accepted one portfolio rule without much question. A major tax shift could change that calculation entirely, forcing difficult trade-offs between risk, discipline and an overlooked cost lurking beneath.

Economy

Population growth masks Australia’s productivity problem

For years, investors have benefited from a seemingly reliable growth story. But recent national accounts raise uncomfortable questions about what has really been driving Australia’s economy and whether that can continue unchecked.

Investment strategies

Why tomorrow’s winners may not be today’s index leaders

The stocks that built retirement balances over the past decade now dominate many portfolios. The new challenge is whether these companies can continue meeting the increasingly high expectations embedded in today's share prices.

Investing

What earnings surprises reveal about future returns

Sometimes the most important information in an earnings result isn't the number itself. It's the possibility that the market's assumptions have been fundamentally wrong and future earnings may look very different.

SMSF strategies

Individual SMSF Trusteeship directly liable for ATO fines

A rarely discussed detail buried in SMSF structures could dramatically change who wears the cost when something goes wrong. With penalties rising, a decision many dismissed as administrative may deserve a second look.

Investment strategies

The currency bet you didn’t know you made

Buying global shares means making two bets: on the companies and on the Australian dollar. Most investors consciously choose only the first. Last financial year, the second bet cost 8.5% in returns for many investors.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.