A rapidly changing world poses new risks to capital markets and creates what seems to be an ever-increasing list of concerns.
Many equity markets appear expensive and macro uncertainty is palpable, leaving investors off balance and often trying to chase yesterday’s hot idea. 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 your risk tolerance, income needs, and investment horizon.
For investors seeking an allocation to assets that have the potential to deliver steady long-term returns with fewer major ups and downs along the way, we believe infrastructure investments fit the bill. These assets have historically outperformed equities and bonds with less risk than equities over time, and they tend to be great businesses with attractive risk/return profiles. These equities also have lower long-term interest-rate sensitivity than many people assume are a hedge against inflation, and they have historically offered attractive yields.
Infrastructure investments have outperformed stock and bond markets
Infrastructure companies hold physical assets whose economic lives are typically measured in decades. Investors can gain exposure to this niche asset class through certain equity sectors, such as utilities and energy. More specifically, the opportunity set includes publicly traded companies that own and operate 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. While these equities may not be as exciting as more cyclical sectors such as technology or consumer discretionary, infrastructure investing offers several benefits that we believe are more valuable over time, including the potential to earn an attractive absolute return while experiencing fewer major ups and downs than the broader market.
Since 1976, the global infrastructure investing universe¹ has outperformed equities by nearly 1% and bonds by nearly 4% on an annualized basis. This long-term relative success has been underpinned by infrastructure’s historical outperformance in most market environments. Other than during equity bull markets, infrastructure investments have delivered better relative returns, capturing more upside than bonds and less downside than either equities or bonds.
Infrastructure investing offers a favorable risk/reward
We’re baffled as to why the market seems to underappreciate infrastructure investing. Many infrastructure companies operate great businesses in that their returns are typically high relative to their level of risk. We believe that the risk/reward equation is favorable because (for many companies in this universe) the firm’s returns on its investment are virtually guaranteed and protected by the assurance of government regulations or long-term contracts. The industries these businesses 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 likely to persist. Finally, in many cases the returns are indexed, or linked, to the local rate of inflation, creating a potential inflation hedge.
Interest-rate sensitivity is modest over the long term
One of the main concerns about utilities and other infrastructure investments is their perceived sensitivity to interest rates. While there can be some short-term impact on these equities during periods of rising interest rates—particularly sharp, unanticipated increases—historical data reveals that infrastructure investments have rebounded, often relatively quickly. Over previous U.S. Federal Reserve (Fed) interest-rate cycles, the global infrastructure investing universe has, on average, outperformed equities before and after rate hikes, performed in line with equities throughout a full cycle, and outperformed bonds before, during, and after rate increases.
Infrastructure investing offers income generation potential
Infrastructure investing can also potentially generate attractive levels of income. The yield on this universe was 110 basis points (bps) higher than equities and 185bps higher than bonds at the end of 2018. While the spread over bonds is partly a reflection of central bank policies that have pushed yields steadily lower in the last 10 years, it’s also indicative of valuations, which suggest that bonds are more expensive. The takeaway is that infrastructure investments have consistently generated competitive income relative to bonds and above-average income relative to equities, making infrastructure a potentially valuable complement to a broader bond or equity portfolio.
Defense and diversification matters—especially in late-cycle environments
Amid a confusing, volatile market, we believe infrastructure investing has the potential to be an attractive option for long-horizon investors and should be considered as a strategic portfolio allocation throughout the market cycle. Given the historical outperformance versus equities and bonds, the favorable risk/reward profile of the business models, resilience following interest-rate increases, inflation-hedging potential, and income-generation potential, these infrastructure assets can potentially give investors one less thing to worry about. As the decade-long bull market—already the longest on record—continues to mature, right now might be a particularly good time to consider the portfolio stabilizing prospects of infrastructure investing.
1 The global infrastructure investing universe comprises 55% utilities, 15% energy, 10% communications, 10% real estate, and 10% industrials.
For the purposes of this article, equities comprise MSCI World Index data from 1976 to 1994 and MSCI ACWI data from 1995 to 2018. Bonds comprise Bloomberg Barclays U.S. Aggregate Bond Index from 1976 to 1989 and Bloomberg Barclays Global Aggregate Bond Index from 1990 to 2018.
Rate-increase cycles were determined based on the U.S. federal funds rate. Periods were selected based on when rate increases were reasonably sustained and when the first hike marked the beginning of a meaningful policy shift. Using available data back to 1976, we identified eight such periods.
The MSCI World Index tracks the performance of publicly traded large- and mid-cap stocks of developed-market companies. The MSCI All Country World Index (ACWI) tracks the performance of publicly traded large- and mid-cap stocks of companies in developed markets and emerging markets. The Bloomberg Barclays U.S. Aggregate Bond Index tracks the performance of U.S. investment-grade bonds in government, asset-backed, and corporate debt markets. The Bloomberg Barclays Global Aggregate Bond Index tracks the performance of global investment-grade debt in fixed-rate treasury, government-related, corporate, and securitized bond markets. It is not possible to invest directly in an index.
The fund’s strategy entails a high degree of risk. Master limited partnerships and other energy companies are susceptible to changes in energy and commodity prices. Natural resource investments are subject to political and regulatory developments and the uncertainty of exploration. The stock prices of midsize and small companies can change more frequently and dramatically than those of large companies. Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. Investments concentrated in one sector may fluctuate more widely than investments diversified across sectors. Investments in higher-yielding, lower-rated securities include a higher risk of default. Foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability. Investments in the Greater China region may be subject to less developed trading markets, acute political risks, and restrictions on monetary repatriation or other adverse government actions. The use of hedging and derivatives could produce disproportionate gains or losses and may increase costs. Liquidity—the extent to which a security may be sold or a derivative position closed without negatively affecting its market value, if at all—may be impaired by reduced trading volume, heightened volatility, rising interest rates, and other market conditions. REITs may decline in value, just like direct ownership of real estate. Please see the fund’s prospectus for additional risks.