In specialized market sectors like infrastructure, active management may be the natural choice for many investors.
For today’s investor, the choice between active and passive management is not an either/or question. Both can—and do—play important roles in building diversified portfolios to meet long-term goals. Yet there are some places where active management may be especially beneficial, including the growing opportunities that exist today in infrastructure.
Active managers seek to outperform benchmark indexes by investing in securities they believe to offer the best potential—and by opportunistically making adjustments to holdings as market conditions fluctuate. For some active managers this process has resulted in solid results for clients over long periods of time.
On the other hand, passive (or index-based) strategies give investors access to all securities within the index the strategy mirrors. As such, performance mimics the index as well. Many passive strategies have attractive track records relative to the broad universe of active managers, especially in traditional sectors such as large company stocks, U.S. Treasuries and developed market corporate bonds.
Yet in market sectors where conditions are more complex, active management may be a natural choice for many investors. As market complexity increases, information about individual securities and market liquidity can be more limited, which may play into the strengths of active managers who have expertise in thoroughly analyzing individual opportunities. Infrastructure certainly qualifies as such a sector.
Market complexity and active management: A conceptual relationship
Bridging the gaps
Investor interest in infrastructure—those physical assets that provide services that are essential for people to live their lives—is building around the world. Whether it’s the refurbishment of existing roads and bridges, the expansion of electricity grids to incorporate renewable energy generation, or the addition of new capacity at airports, railways and ports to meet the demands of growing populations, there is a global need that must be met if economies are to continue to grow and prosper.
While the public sector will remain a major source of financing, private capital is playing a larger role in financing infrastructure today more than ever before, given fiscal constraints and the sheer magnitude of the need. That in turn is creating broader opportunities for investors to meet some of their own objectives.
For example, finding competitive income remains a challenge today's low bond yield environment. With attractive yields available in infrastructure, an active manager who understands the fundamentals of company analysis may add value to a portfolio helping investors achieve the income they seek.
In addition, within a portfolio, infrastructure can offer other important benefits as well:
- Lower volatility – Even during times of economic weakness, demand is relatively stable for regulated assets such as water, gas and electricity, which means those essential service assets tend to have resilient revenues and exhibit lower volatility than traditional equities during various business cycles.
- Stable cash flow – Infrastructure companies provide predictable income distributions due to stable earnings derived from the underlying asset. For investors, this can provide excellent visibility for revenues and dividends.
- Inflation protection – Most infrastructure assets have an explicit link to inflation through regulation, concession agreements or contracts which provide inflation protection to investors.
- Diversification – The global nature of the infrastructure opportunity makes it a potentially attractive way to increase diversification.
Yet experience and expertise is critical to understanding the multiple factors that help determine whether a potential investment in infrastructure is—or is not—an attractive opportunity.
With the expertise that comes from investing in infrastructure for years, Legg Mason investment manager RARE is well qualified to call itself an infrastructure specialist managing funds, rather than a fund manager managing infrastructure.
The listed advantage
While infrastructure assets all share certain characteristics like historically dependable cash flows, RARE is focused solely on listed assets that have a higher level of liquidity than non-listed assets, because they trade in the securities markets. The fact they’re publically traded securities means they experience price fluctuations that allow RARE the opportunity to take advantage of short-term mispricing—something that passive strategies cannot do.
RARE is specifically focused on regulated assets and user pays assets. Regulated assets include companies operating in water and wastewater operations and gas/electric transmission and distribution. These companies tend to be defensive assets whose revenues remain relatively stable across economic cycles. User pays assets are growth oriented and thus more highly leveraged to GDP. They include such assets as airports, toll roads, railways, ports and communications companies.
Different characteristics and varying degrees of risk
Types of infrastructure assets
RARE adopts a fundamental bottom-up investment approach to stock selection seeking long-term opportunities in assets that trade at a discount to what it believes to be the appropriate value. Since assets are considered globally, RARE takes into accountregulatory, legal and political frameworks that govern in different countries and regions.
By selectively choosing assets, RARE seeks an optimal combination of regulated assets for cash flow and income stability and user pays assets for growth opportunities, as fees for these companies are ultimately determined by how much people use them.
Through determining which assets to include—and exclude—from the portfolio and how to weight each of them; as well as by taking advantage of opportunities to buy and sell as market conditions fluctuate, active managers such as RARE seek to offer investors a different overall risk/return profile than they could achieve through an all-inclusive passive index-based approach.
This is the first in a series of articles about specialized sectors where active management could be a natural choice for investors. Look for upcoming articles related to real estate, alternative strategies and direct lending.