Could investing in infrastructure safeguard against inflation in 2022?
TINA has been a much-used acronym in the investment world this year. It stands for ‘There Is No Alternative’ and it has been used to explain the situation where stocks rise because, despite any reservations they may have, investors invest in them because they believe there is no viable alternative.
However, investment opportunities have moved on considerably from when the only ‘alternative’ in the acronym was considered to be bonds. For investors looking to diversify publicly-quoted equity risk and generate income-driven returns, the broad sector of investing in infrastructure and transportation could be worth considering.
If you are interested in investing in infrastructure and transportation, this article explores the key considerations, particularly if you want to invest in infrastructure as a means of protecting against inflation – which the Bank of England forecasts may hit 6% in early 2022 – and why we believe infrastructure will be a key investment theme in 2022.
What are the advantages of investing in infrastructure and transportation?
There are currently three key attractions:
- Firstly, many infrastructure investments have built-in inflation protection
- Secondly, the global push on infrastructure spending by governments
- Thirdly, much of the money is directed towards areas that are needed if we are to successfully decarbonise, which is clearly high on many government agendas worldwide.
How does infrastructure have built-in inflation protection?
With inflation climbing higher and expected to reach 6% in spring 2022, achieving real (above inflation) returns is a key goal - and many infrastructure assets have an explicit link to inflation built in to returns.
For regulated assets such as utilities, this is through the returns allowed by regulators; and most countries have a process by which, over the medium term, these returns should rise and fall in line with rises and falls in the underlying cost of capital.
Other infrastructure investments, such as toll roads or social housing, have concession agreements in place which can provide inflation protection. Yet others, such as renewable power generation, have contracts which are long-term in nature and generally have periodic escalators linked to inflation.
Those infrastructure projects/companies that do not have an explicit link to inflation are generally providing essential services to society, so often have the pricing power to deliver inflation-matching, or inflation-beating, outcomes, as reflects their strong strategic position. For core infrastructure these returns come largely from the cash yield that the asset provides, meaning not only a good level of income, but a very steady one, for investors.
How will government spending impact infrastructure?
Governments are currently investing significant sums in infrastructure and transportation.
The US passed its US$1trn Infrastructure bill in November 2021, with the US$1.75trn ‘Build Back Better’ bill still to come. In the UK the government confirmed a £100bn commitment to infrastructure in 2020-21 with £19bn available for transport projects. Similar commitments have been made in the EU, Japan & Canada.
This provides significant investment opportunities in public infrastructure, in addition to investments via private companies.
How will decarbonisation and the climate change agenda impact infrastructure?
Many of the opportunities to invest in infrastructure and transportation will arise from the decarbonising agenda.
With nearly every major economy committing to the UN’s Sustainable Development Goals and the Paris Agreement, a significant upgrade to existing means of power generation, transportation, global trade and industrial production are required to meet these goals. This encompasses many aspects such as the push for cleaner power and electric vehicles, and increased digitalisation and other areas of innovation.
Following from COP26, nearly 500 global financial firms have agreed to align US$130trn of investment to support the net zero transition. Projects that are structured to meet essential needs of the population and are based on sustainable principles are attracting significant capital investment. They will deliver the smart and resilient infrastructure of the future which, according to the World Bank, is likely to prove more profitable as it makes for more reliable services and greater resilience to extreme weather events. However, the caveat is that projects incorporating emerging technologies are much higher risk, as there is an increased possibility of them not being able to deliver.
What are some potential disadvantages of investing in infrastructure and transportation?
Of course, there are things to watch out for too. Infrastructure is a capital-intensive sector, so it is important for infrastructure companies to maintain an appropriate debt structure so that inflation-linked price increases flow through to the bottom-line.
The sector is subject to government interference and changes in the regulatory environment can impact it.
Infrastructure is also an illiquid asset class, so requires a long-term time horizon and may cause a timing mismatch if investors want to sell out of a fund comprised of difficult-to-realise assets. Indeed, the valuation of those assets is based on an appraisal of their value, which may be negatively impacted by market dislocations- i.e. major market events.
How to invest in infrastructure and transportation
In addition to investing in listed infrastructure companies, there are both open-ended and closed-ended funds which offer access to private market infrastructure opportunities for investors. The range of options has widened significantly in the past few years as the definition of infrastructure has expanded.
Assets not only include the traditional infrastructure subsectors of utilities, social infrastructure, transportation and energy, but now also encompass newer subsectors, such as digital infrastructure, energy transition and storage infrastructure, stretching through to healthcare and education businesses and infrastructure services businesses.
At Canaccord, we have an active Alternatives Committee that employs stringent selection criteria, resulting in a concentrated list of high-quality investment opportunities. This gives clients access to investments from classic infrastructure to mobile towers and fibre-optic cabling; from GP surgeries to battery storage. And while we remain fully committed to global equities as an asset class, we also use alternatives widely in balanced client portfolios where we believe they can provide an important ‘alternative’ to equities, particularly in these times of rising inflation. We see alternative investments in infrastructure being a key investment theme in 2022.
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Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.
The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.
This is not a recommendation to invest or disinvest in any of the companies, themes or sectors mentioned. They are included for illustrative purposes only.
The information contained herein is based on materials and sources deemed to be reliable; however, Canaccord Genuity Wealth Management makes no representation or warranty, either express or implied, to the accuracy, completeness or reliability of this information. Canaccord is not liable for the content and accuracy of the opinions and information provided by external contributors. All stated opinions and estimates in this article are subject to change without notice and Canaccord Genuity Wealth Management is under no obligation to update the information.
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Investment involves risk and you may not get back what you invest. It’s not suitable for everyone.
Investment involves risk and is not suitable for everyone.