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

2 billion reasons to fix retirement income

A proposal to address Australia's 'stranded balances' in retirement by requiring super funds to transition members to pension phase at 65, boosting retirement income and reframing super as a source of income.

The ultimate superannuation EOFY checklist 2026

Here is a checklist of 28 important issues you should address before June 30 to ensure your SMSF or other super fund is in order and that you are making the most of the strategies available.

Do super funds need a massive wake up call?

UK retirement expert, Guy Opperman, believes super funds are failing at supporting members in deaccumulation. Here is what Australia should do about it. 

Two months into retirement

A retirement researcher's take on retirement and her focus on each of her six resource buckets to stay engaged during the transition and beyond.

Welcome to Firstlinks Edition 662 with weekend update

The debate over the budget is increasingly shaped by frustration and perceptions of unfairness, rather than clear-eyed assessment of policy outcomes.

Reforming the taxation of wealth and wealth transfers

As the budget approaches debate continues about the need and method for addressing wealth inequality. Could reinstating wealth transfer taxes be the answer?

Latest Updates

Back to the future - Why indexing CGT is a good idea

A return to indexation of capital gains would be a fairer way to compensate households for the effects of inflation than the current discount. Importantly, it opens the door to future, broader reforms to stop the taxation of inflation.

Australia has no death duties. Technically.

Australia may not levy formal death duties, but a growing web of tax measures is quietly shaping what wealth passes between generations. Now, the 2026 budget adds another layer.

Strategy

The folly of the Iran war

From oil shocks to fractured alliances, the Iran war carries the hallmarks of a historic policy misstep - one that could tip an already fragile global economy into crisis.

Taxation

Noel Whittaker’s take on the budget

Marketed as a fix for inequality and housing affordability, the latest budget instead delivers a tangle of tax changes that leave everyday Australians worse off.

Investment strategies

The red metal's long game

Copper has had a rough few weeks but investors should not ignore the potential for future price increases as supply increasingly falls behind demand.

Taxation

The lesser-known effects of changed property taxes

The budget’s property tax reforms are being framed as fairness measures, but they risk splitting the housing market, penalising lower‑income investors and introducing distortions that may prove costly.

Latest from Morningstar

Why stocks sometimes fall for no obvious reason

The vast and opaque world of private assets is a powerful gravitational force - and when trouble hits, it's the more liquid public equities that often the feel it first.

Sponsors

Alliances

© 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.