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.

 


 

Leave a Comment:

banner

Most viewed in recent weeks

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Latest Updates

Superannuation

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

Superannuation

Less than 1% of wealthy families will struggle to pay super tax: study

An ANU study has found that families with at least one super balance over $3 million have average wealth exceeding $19 million - suggesting most are well placed to absorb taxes on unrealised capital gains.   

Superannuation

Are SMSFs getting too much of a free ride?

SMSFs have managed to match, or even outperform, larger super funds despite adopting more conservative investment strategies. This looks at how they've done it - and the potential policy implications.  

Property

A developer's take on Australia's housing issues

Stockland’s development chief discusses supply constraints, government initiatives and the impact of Japanese-owned homebuilders on the industry. He also talks of green shoots in a troubled property market.

Economy

Lessons from 100 years of growing US debt

As the US debt ceiling looms, the usual warnings about a potential crash in bond and equity markets have started to appear. Investors can take confidence from history but should keep an eye on two main indicators.

Investment strategies

Investors might be paying too much for familiarity

US mega-cap tech stocks have dominated recent returns - but is familiarity distorting judgement? Like the Monty Hall problem, investing success often comes from switching when it feels hardest to do so.

Latest from Morningstar

A winning investment strategy sitting right under your nose

How does a strategy built around systematically buying-and-holding a basket of the market's biggest losers perform? It turns out pretty well, so why don't more investors do it?

Sponsors

Alliances

© 2025 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.