Compelling investment opportunities have become harder to find.
Right now, many equity markets appear expensive, and fixed-income valuations seem even more stretched. Meanwhile, macroeconomic uncertainty has grown palpable, leaving investors confused and tempted to chase yesterday's hot idea.
For investors seeking allocations that have the potential to deliver steady long-term returns, with relatively muted ups and downs along the way, we believe enduring assets fit the bill. They tend to represent great businesses with attractive risk/return profiles. The equities of these companies have also demonstrated long-term resilience against inflation and interest-rate risk while generating attractive yields.
Enduring assets are physical assets whose economic lives are typically measured in decades. The opportunity set includes shares of companies with electric, gas, and water networks; power-generation plants; and oil and gas pipelines. It can also extend to transportation infrastructure such as highways, railroads, and port facilities, and even telecommunications infrastructure.
Infrastructure and other enduring assets offer an attractive risk/reward profile
The market perennially underappreciates enduring assets. While these equities may not be as exciting as more cyclical sectors, such as information technology or consumer discretionary, they offer several benefits we view as more valuable over time. These companies tend to have great businesses in that their returns are typically high relative to their level of risk.
While their returns may not keep up with those of riskier, higher-beta holdings during strong bull markets, we believe that the risk/reward equation for enduring assets strikes a favorable balance; for many stocks in this universe, companies' returns on investment are set by government regulations or long-term contracts. Moreover, the industries they typically operate in are considered public goods, beneficial and necessary for society. That status, along with the durable characteristics of the underlying assets (the actual roads, power plants, grids, and so on) means that underlying returns are more likely to persist. Finally, in many cases, returns are indexed, or linked, to inflation, creating a potential inflation hedge.
Interest-rate sensitivity of enduring assets is modest over the long term
One of the chief concerns about enduring assets is their perceived sensitivity to interest rates. While there can be some short-term impact on equity prices during periods of rising interest rates—particularly sharp, unanticipated increases—historical data suggests that enduring assets can rebound quickly. Over previous U.S. Federal Reserve (Fed) interest-rate cycles, the enduring assets universe has historically outperformed equities before and after rate hikes, performed in line with equities throughout a full cycle, and outperformed bonds, on average, before, during, and after rate increases.
Enduring assets serve as a potential source of investment income
Enduring assets can also potentially generate attractive levels of income. As of the end of 2016, the yield on this universe was more than 1% higher than equities and nearly 2% higher than bonds.
While today's spread over bonds is partly a reflection of central bank policies that have pushed yields steadily lower the last 10 years, it's also indicative of valuations, which suggest that bonds are more expensive. The takeaway is that enduring assets have consistently generated competitive income relative to bonds and above-average income relative to equities, making them a potentially valuable complement to a broader bond or equity portfolio.
In our view, the fundamental way to make money in the markets hasn't changed: Identify the best potential long-term investments and allocate to them appropriately based on risk tolerance, current and future income needs, and time horizon. Amid a confusing, volatile market, we believe enduring assets are an attractive option for long-horizon investors and should be considered as a strategic portfolio allocation. Given their historical outperformance versus equities and bonds, the favorable risk/reward profile of the business models, resilience following interest-rate increases, inflation-hedge potential, and income-generation potential, these infrastructure assets can potentially give investors one less thing to worry about.