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building a real asset portfolio

The lack of correlation that a diverse portfolio of real assets has with equities has seen the popularity of infrastructure investing go through the roof. By Caroline Shaw

Many people consider its relationship with the MSCI World Infrastructure Index, but this consists of shares in infrastructure companies such as electricity, oil, gas and water. There is, therefore, a large degree of correlation with global equities, which is higher over longer time periods (see table 1). If you are looking for the correlation benefit of infrastructure, then it is advisable to avoid pure equity investments since, generally, these will struggle in an equity bear market.

Let’s instead consider actual infrastructure assets. Infrastructure is defined by the OECD glossary as “the system of public works in a country, state or region, including roads, utility lines and public buildings”. This includes economic infrastructure (roads, communications) and social infrastructure (hospitals, schools).

Typical characteristics of such investments are high barriers to entry (it costs a lot to build, operate and effectively own a hospital), long-term time horizons, predictable cash flows (assets are generally leased using long-term contracts) and inflation protection (payments are usually at least part linked to inflation).

How to gain exposure

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A direct investment for most individuals is impossible, so a closed-ended listed fund is the most appropriate way to obtain exposure. Unlisted products and private equity may also provide exposure, though both of these generally carry higher risk. We analysed the correlation of four closed-ended funds with at least a one-year track record (see table 2).

None of the closed-ended funds have any significant correlation with the equity indices or the MSCI World Infrastructure Index. The correlations with corporate bonds are not significantly high. The lack of correlation with equities means that an infrastructure portfolio will not race away in an equity bull market, but it is likely to provide some stability in a downturn.

Going public

Generally, with a large public project, the government or local authority outsources the construction to another entity, which builds and operates the asset and then the government or local authority leases the asset. Infrastructure funds may own the asset and, therefore, the right to the regular payments.

For me, a really attractive property of infrastructure is the fixed interest-like characteristics that derive from an actual road, building, bridge, hospital or school being leased to a government entity. Owning the right to this income, often inflation-linked, is not dissimilar to owning sovereign debt. It is essential to ensure that the sovereign is creditworthy and the terms for the payments are also worth considering carefully.

For example, availability fees are paid whenever the asset is available, such as when a hospital or road is open, but toll fees are based on traffic numbers. This makes the tolls more unpredictable.

There are other considerations for a portfolio of real assets. These include diversification across sectors (so the portfolio is not all related to roads, for instance), across a number of assets and across a variety of counterparties (sovereigns in many cases).

Political risk and diversification

It might be reasonable to assume that the German Government is good for annual payments for a bridge. It might not be so obvious to assume the Russian Government is good for payments on a railway. Political risk should not be underestimated. The current PFI review in the UK is one example of the impact of changing views across successive governments. Supply and demand for infrastructure projects can be skewed heavily, affecting pricing of infrastructure products.

The status of the projects is also important. Completed projects are more secure than those under construction or those in the design/tender phase where there are risks that completion will not be achieved. Lastly, the pipeline of new assets should be considered. Many infrastructure funds are clearly linked to a construction company. The rights of the fund to purchase those company projects should also be analysed.

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We bought the Luxembourg-domiciled Bilfinger Berger Global Infrastructure Fund (closed-ended) to get exposure to a broad range of international assets with payments from AA-rated governments. The fund has a pipeline of assets from a construction giant, who was also a major seed investor. It has a diverse range of assets across many sectors and countries offering genuine global infrastructure exposure.

 

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