A marathon, not a sprint: assessing the opportunity in enduring assets

Completing the 26.2 miles is among the greatest achievements in sports, and many who try fail to finish. But some people make the grueling feat seem easy. Joy Johnson, a California schoolteacher, took up running at age 59, completed her first New York marathon several months later, then proceeded to compete every year for the next 25 years.

Ms. Johnson's remarkable consistency is a metaphor for a subset of the infrastructure sector that we call enduring assets: publicly listed companies that own or operate physical assets with long economic lives, typically 20 years or more. Electric, gas, and water networks; power plants; fuel pipelines; transportation infrastructure; and portions of the real estate and communications sectors are examples. Research shows that a composite set of these assets has delivered a historical track record that would make most marathoners smile.

Since 1973, when reliable data was first available, the enduring assets universe—represented by 55% utilities, 15% energy, 10% communications, 10% real estate, and 10% industrials—has delivered 10% annual returns, outperforming global equities by 1% annually; even more impressive, these assets have had 10% less volatility, leading to a 25% higher return/risk ratio than that of global equities.¹

Like any investment, intermittent periods of challenging performance have occurred with enduring assets, and 2015 was one such year. Near-term concerns about rising interest rates, fears of sluggish economic growth, and sharp drawdowns in commodity prices contributed to softer performance. History shows, however, that corrections have provided attractive entry points over the years.

Since 1973, there have only been nine calendar years marked by negative performance, and these drawdowns have generally been brief, most lasting fewer than nine months. Outside of the 2008 global financial crisis, only the 2001 drawdown lasted longer. Today, an inflection point may already be under way; although past performance does not guarantee future results, 2016 year-to-date performance for enduring assets seems to be following historical patterns by starting off strong, particularly relative to broader equities.

Following these short, relatively infrequent drawdowns, rebounds following enduring asset corrections have often been strong. Not counting 2015's drawdown, since 1973, the average one-year return following a negative year has been 19.1% for the enduring assets universe, and the average annualized five-year return following a negative year has been 15.8%.²

For all of these reasons, we believe that a weak 2015 has presented investors with a clear buying opportunity in 2016. We're not advocating attempts to tactically time entry or exit points, but given the pattern of strong rebounds following corrections and sustained long-term performance for enduring assets, we believe now may be a sensible time to consider initiating or increasing an allocation.

Today's lack of inflation is another reason to consider adding to this market segment. The enduring assets opportunity set has been a natural hedge for inflationary pressures, as many of the underlying assets have direct or indirect links to inflation through regulated contracts. From 1973 through 2015, these assets have delivered competitive average annual returns in periods of stable inflation (12%) and rising inflation (7%). In our view, deflation shouldn't last; the market is more likely to be surprised by the success of central banks in reflating asset prices.

While current consensus expectations imply a muted outlook for inflation in the near term, recent experience has almost always biased forecasters' inflation expectations. As a result, inflation often occurs when it's least expected, causing it to be particularly damaging for unprepared portfolios.

We believe enduring assets' attractive long-term return/risk profile warrants their consideration as an ongoing complement to a diversified investment portfolio. We also believe their weak performance in 2015 presents an entry point for investors looking to initiate or add to their allocation. If history's a guide, the recent drawdown is unlikely to last much longer or go much deeper, and a subsequent rebound in returns may be strong. When inflation finally does pick up, enduring assets will be poised to provide a portfolio holding them with a substantive hedge. Enduring assets may offer investors a consistent, if less than flashy, source of risk-adjusted returns. And as we imagine the 59-year-old Ms. Johnson might have told herself before taking up running, there's no time like the present.

1 The enduring assets universe comprises 55% utilities, 15% energy, 10% communications, 10% real estate, and 10% industrials, drawn from Datastream World Index sector data from 2/1/73 to 12/31/94 and MSCI ACWI Index sector data from 1/1/95 to 12/31/95. Global equities are represented by the MSCI World Index from 2/1/74 to 12/31/94 and the MSCI All-Country World Index from 1/1/95 to 12/31/15. Volatility is represented by standard deviation. Return/risk ratio is represented by the annualized return divided by annualized standard deviation. The Datastream World Sector Index tracks a range of equities across sectors, countries, and regions worldwide, covering at least 75% to 80% of total market capitalization, and is allocated to the industrials sector using the Industry Classification Benchmark. The MSCI World Index tracks the performance of publicly traded large- and mid-cap stocks of developed-market companies. The MSCI All Country (AC) World Index tracks the performance of publicly traded large- and mid-cap stocks of companies in 23 developed markets and 23 emerging markets. It is not possible to invest directly in an index. Past performance does not guarantee future results. 2 Datastream, MSCI, FactSet, Wellington Management, 2016.