It has been a remarkable 18 months for infrastructure but it should come as no surprise that the pandemic's impact on infrastructure assets has been varied. In a sector that consists of a range of industries and assets, which are often subject to differing underlying drivers, asset performances can fluctuate.
Assets like airports and toll roads have suffered from reduced travel, many regulated and social assets were resilient, while communications and technology infrastructure enjoyed an environment of increased demand.
So given the varied performances, what might the road to recovery for infrastructure look like? And what role could infrastructure play in a portfolio?
Our recent webinar Infrastructure and the road to recovery examined each of the different categories of infrastructure and how we believe they may perform as the world learns to live with COVID. (needs link)
Infrastructure consists of a broad array of assets which can be categorised in a number of ways, but a common approach is to look at them by sector. Different sectors – and indeed different individual assets – can have varying characteristics that affect their performance depending on what is going on in the broader global economy.
1. Social infrastructure
The first category is social infrastructure, which is often structured as public private partnerships (PPPs). PPPs are a common way of delivering infrastructure through a partnership between private investors and the public sector. Social infrastructure includes assets like schools, hospitals and justice facilities.
Importantly, for investors, these generally have an availability-based revenue model. This model means the owner of these assets gets paid for making the asset available, regardless of how many people use the asset. The payments are often fixed and usually from a government counterparty, which provides high security of revenues for the investors.
Because these types of assets are not impacted by volume or by usage, they tend to be largely immune to what is going on in the broader economy and so were not greatly affected by COVID-19.1 A key feature of social infrastructure is the stability of revenues driven by factors such as the availability-based revenue model, and the fact they are often coming from a highly rated government counterparty.
2. Regulated infrastructure
The second category consists of regulated assets, which is typically characterised by inelastic demand because these assets provide essential services that we use every day like water and electricity.
These assets have regulated pricing models, meaning pricing is determined by a regulator under a regulatory framework that applies over an extended period. In many jurisdictions, this period can be five years, although for some assets it can be longer.
Due to the inelastic demand and regulated pricing, we saw many regulated assets perform quite resiliently during the pandemic, though we did observe some assets being impacted by heightened risks, including higher counterparty risk (as they depend on customers paying their bills), as well as increased regulatory risk in some jurisdictions.
3. Volume-based (or patronage-based) infrastructure
The third category — and, in our view, the most impacted by COVID-19 — is volume-based infrastructure or patronage-based infrastructure. These are assets like airports, toll roads and seaports that have revenues reliant on the level of usage.
Still, even within this sector, we saw different assets perform differently. Toll roads were impacted by lockdowns as traffic movements were lower, but as lockdowns lifted movement quickly picked up.
It is clear that the airports sector has been greatly impacted due to ongoing travel bans. For example, passenger numbers at Australia's airports fell dramatically relative to pre-pandemic levels due to the restrictions.
4. Communications infrastructure
The fourth category is communications infrastructure, which includes assets like telecommunications towers, data centres and fibre networks.
The high demand for data due to increasing usage of things like streaming services and video conferencing meant this sector was already performing strongly pre-COVID.
The pandemic saw demand for data increase further as people moved work online and this, in our view, will mean communications assets will continue to do well.
So, what is the role of infrastructure in a portfolio?
People have different perceptions around this question, but we believe a well-diversified infrastructure holding in a broader portfolio can play a number of roles.
First, it can provide consistent returns. Infrastructure tends to be relatively resilient through market cycles. While it is not immune from the wider economic cycle, many infrastructure assets provide essential services that people use on a daily basis, which can provide resilience. Services like water and electricity enjoy relatively consistent levels of demand and are generally less influenced by economic factors and market cycles than other types of businesses.
Second, infrastructure can provide a portfolio with diversification. Typically, infrastructure has a low correlation to many other asset classes, which can help to lower overall portfolio risk.
Third, infrastructure has the potential to provide lower volatility and some level of drawdown protection when markets are falling due to the essential services nature of the assets. Though the flip side of this is that when equity markets are booming, infrastructure is unlikely to demonstrate the same type of returns.
Fourth, infrastructure can offer a level of inflation protection as many infrastructure assets have revenues that are linked in some way to inflation.
And finally, infrastructure can offer stable income to a portfolio as the revenues that many infrastructure assets generate are often set by regulation or under long term contractual arrangements.
So where to next for infrastructure?
As demonstrated by their performance during COVID-19, we believe each sector will likely perform differently as the world recovers from the pandemic.
While passenger movements at airports have been affected by the pandemic, in our view, there is a high level of pent up demand for travel, and we are likely to see passenger numbers bounce back relatively quickly as restrictions are eased. That said, we believe it will probably take several years for traffic to return to pre-pandemic levels.
Social infrastructure and regulated assets are likely to be fairly resilient in our view. Meanwhile, we believe communications infrastructure will likely continue to thrive as the demand for data continues to proliferate.
That means overall, we view the outlook for infrastructure as quite resilient.
We believe the essential services nature of these assets will likely continue to be attractive to investors due to their relatively stable cash flows, and, in our experience, as governments look to infrastructure as a means of driving economic growth, it is likely there will be further opportunities for investors.
John Julian is Fund Manager of AMP Capital Core Infrastructure Fund and Managing Director at AMP Capital, a sponsor of Firstlinks. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. For a list of sources and important disclaimer information, see the here.
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