Infrastructure assets that are regulated monopolies or governed by long-term contracts may be less sensitive to economic fluctuations.
One key feature of infrastructure equities is the relative resiliency of earnings through market cycles.
Consider, for example, utilities which provide essential services such as electricity, water and gas. As monopolies, they are typically regulated to ensure monopolistic power is not abused. They are also asset-intensive businesses requiring vast amounts of capital expenditure to maintain and ensure delivery to the end user.
Consequently, regulators must strike a balance between not allowing overcharging, but ensuring an adequate return on capital that incentivises the utility company to continue to invest into these essential infrastructure assets.
The net result is relatively predictable, steady, defensive earnings which are less sensitive to fluctuations in economic conditions or asset markets.
As seen in the chart (blue line), these companies have steadily increased Earnings Before Interest, Tax, Depreciation & Amortization (EBITDA) quarter after quarter, year after year -- even during the midst of the Global Financial Crisis (GFC).
Transport infrastructure, such as toll roads and airports, are examples of infrastructure assets that are governed by long term contracts rather than regulation and with revenues that have some sensitivity to usage volumes.
Since these are long term contracts and assets that have some monopolistic characteristics, shares of these companies are more defensive than other parts of the stock market. However, because the number of people using an airport or driving on a toll road does have some sensitivity to what’s happening in the wider economy, earnings can be a bit more volatile than that of utilities. As per the accompanying chart (green line), EBITDA did drop during the GFC, however, no-where near as much as global equities (grey area).
Source: FactSet, RARE and Legg Mason, as of 12/31/2018. Utilities and Infrastructure EBITDA in local currency, Global Equity in USD, measured by the MSCI World Index. Please refer to “definitions “for more information. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
The Bottom Line
Owning infrastructure stocks is akin to having a claim on a long stream of reliable and predictable free cashflow. This free cash flow is anchored on solid, government regulated or contracted returns from physical assets. Investors will find that this all-weather earnings stability makes infrastructure equities an ideal candidate for introducing defensiveness into a global portfolio.
Developed markets (DM) refers to countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is a measure of a company's net profit.
Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.
The financial crisis of 2007–2008, also known as the global financial crisis (GFC) and the 2008 financial crisis, was a severe worldwide economic crisis considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s, to which it is often compared.
Standard deviation (St. Dev) is a statistic used as a measure of the dispersion or variation in a distribution, or dataset, from its mean, or average; it measures the volatility of an investment’s return over a particular time period; the greater the number, the greater the volatility.
The MSCI World Index captures large and mid-cap representation across 23 Developed Markets countries.