Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 182

Populism and the risks in regulated assets

Global monetary authorities are continuing to engineer a low bond yield environment in an ongoing effort to stave off the onset of economic stagnation. Against this backdrop, interest in infrastructure as an asset class has intensified, offering yields that look appealing to retail investors and liability-driven institutional investors such as defined-benefit pension funds and insurers.

But before simply treating infrastructure as a ‘bond-proxy’, investors need to understand its unique characteristics. Foremost of these is the presence of regulatory risk, which represents arguably the strongest case for treating infrastructure as a separate asset class from broader private equity or ‘real asset’ allocations.

By virtue of their monopolistic positions (underpinned by inelastic demand for essential services and prohibitively high barriers to entry), ‘core’ infrastructure assets such as utilities are typically subject to some form of economic regulation. Not surprisingly, regulatory risk is a key issue. In one survey, it was nominated as the biggest challenge by respondents, outstripping macroeconomic risk, manager selection and other issues.

Complexities of assessing risk

However, assessing and managing regulatory risk can be difficult. For instance, regulatory and political risk are often seen as synonymous. Yet there is an argument that a business directly subject to government decisions should be treated differently to one that has the protection of a separate and independent rule-bound regulator which must balance all stakeholder interests. In the UK, for instance, the water regulator has a statutory responsibility to ensure the financial feasibility of privately owned water companies.

Prima facie, this reduces the likelihood of the regulator imposing an adverse and financially crippling decision. Contrast this with the more heavy-handed fate suffered by the Gassled investors at the hand of the Norwegian government’s oil and energy ministry, and it is easy to see why rule-bound regulators are something of a shield from opportunistic politicians. This distinction has become ever-more crucial in the wake of populist election results such as Brexit and Donald Trump’s US presidential victory.

A further layer of complexity stems from the fact that regulation is dynamic, and that regimes can be expected to evolve over time in response to changes in the broader economic, political, and technological environment. Across our portfolio, we have already seen a progression from cost to incentive-based forms of regulation. In some of the more mature jurisdictions we operate in, regulation has evolved further still – with regulators employing a variety of new tools, methods and approaches in response to changing regulatory priorities.

The UK is perhaps the best example of this evolution. Developed in the 1980s in response to the ‘gold-plating’ observed under cost-based regimes in the US and elsewhere, the ‘British model’ of incentive regulation worked very well for two decades (and subsequently was adopted worldwide).

By the late 2000s, however, questions were being raised about the continued efficacy of the incentive scheme. This led to a once-in-a-generation overhaul of regulatory regimes in several UK sectors.

A hallmark of the new systems included smarter mechanisms designed to overcome the classic information asymmetry that exists between a typical regulated utility and the regulator. They also included an emphasis on innovation, ‘capex-lite’ solutions and more direct customer engagement. Regulators worldwide are also seeking to design systems incorporating behavioural economics insights, which have revealed how customer inertia and biases can lead to perverse and costly outcomes.

Investors in Australia are taking note, as it is only a matter of time before some of these features are introduced here. The current political machinations aside, our vast power networks have to contend with the economic reality of high maintenance costs, an increasingly distributed generation landscape and a fit-for-purpose model of regulation.

Changing risk-reward profile of regulated assets

Our view is that these latest innovations in regulatory design will fundamentally change the risk-reward profile of regulated assets. Specifically, they have the potential to increase both outperformance and underperformance. Investors will therefore need to evaluate the ‘alpha’ potential of specific companies rather than seek generic ‘beta’ exposure to a given sector.

Another lesson is that, with so many potential triggers for change, it is dangerous to characterise a historically ‘benign’ regulatory regime as less ‘risky’. Indeed, the opposite could be argued: a regime that has just undergone a step-change can be viewed by investors as ‘de-risked’ for a period of time.

So what are the keys to success in this brave new world of infrastructure regulation? In our view, they include a sufficiently long-term investment horizon, strong shareholder representation and associated control, a proactive approach to stakeholder management and a focus on sustainable, operationally efficient, and customer-driven outcomes.

 

Ritesh Prasad is a Senior Investment Analyst in the Unlisted Infrastructure team at Colonial First State Global Asset Management. This article provides general information not specific to any investor’s circumstances.

 

  •   17 November 2016
  •      
  •   

 

Leave a Comment:

banner

Most viewed in recent weeks

It’s time for LICs to die

A high-profile dividend cut and a prominent fund manager’s apology have reignited a long-running debate. If investors can access similar exposures more cheaply and efficiently elsewhere, what exactly is keeping LICs alive?

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.

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.

The retirement scorecard: how many of these questions can you answer?

From the maths of retirement, estimating spending and picking the right asset allocation to survive a poor decade, here are the questions every retiree – current or future – should be able to answer for themselves.

How the typical Australian Family could save $844,350 in taxes

The value of a testamentary trust is not determined by wealth alone. Depending on circumstances, it can reduce the tax burden on inherited income, create efficiencies and help build intergenerational wealth.

The housing slide could become a crash

House prices are sliding across Australia, yet the most dangerous ingredient for a housing crash is still missing. If job losses surge amid growing economic risks, today's correction could become a historic property downturn.

Latest Updates

Testamentary trusts: Treasury has picked the wrong reading

A decades-old estate planning tool has survived one tax crackdown only to be caught by another. The surprise isn't who the reform is targeting, but who could end up paying the price for drafting choices made years ago.

Latest from Morningstar

Does an American retirement rule work for Australians?

The 4% rule has survived decades of scrutiny, but Australia's retirement system changes the equation in ways most overlook. Before accepting or rejecting this rule of thumb, it pays to understand what really drives retirement outcomes.

Shares

Glencore lands on the ASX. Should BHP and Rio shareholders switch?

A coal-heavy miner with governance concerns isn't the obvious choice for investors. Yet, Glencore's ASX listing may offer something BHP and Rio can't. The challenge is working out whether the opportunity outweighs the risks.

Why does the system treat capital gains and losses differently?

Investors are often told not to let tax policy drive their investment decisions. Yet, under the new CGT rules, portfolio construction, volatility and even how assets are owned may have an outsized impact on their final outcome.

Economy

Three common sense reforms that Australia needs

What do frozen bank accounts, mortgage traps and pension penalties have in common? They're all symptoms of a system that makes life much harder. Yet the obvious solutions seem to have escaped the attention of Canberra.

Shares

The hidden cost of government debt for investors

Some of the important effects of rising public debt never make the headlines. Research shows the immediate effects may already be unfolding, influencing corporate behaviour in ways that many investors would never suspect.

Investment strategies

When do fundamentals matter?

Is fundamental investing losing its grip on markets? Investors continue to search for valuation-based explanations for every price move, but the dominant force behind short-term returns may be something else altogether.

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.