Until recently, I had never really thought of infrastructure as a separate asset class. It encompasses everything from hospitals and schools to water, waste, transport and power.
Like any specialist investment, there is a danger of finding yourself overexposed because generalist fund managers may also hold it within their funds. However, when a big bank such as Macquarie builds up one of the world’s biggest investment teams specialising in the area, perhaps it is worth a second look.
Macquarie has 11 funds under management in this area with a total size in excess of $4bn. I was fortunate enough to meet chief executive officer and portfolio manager Jon Fitch, who explained there had been massive expansion of the sector over the last 10 years.
The range of business was much bigger than I originally thought. He favours essential service businesses, such as water, power, roads and airports, but also wants them to have a good strategic position such as a monopoly or extremely high barrier to entry. Another key characteristic he looks for is a defined structure in terms of how pricing is set, either through regulation or long-term contracts.
Macquarie’s focus tends to be on two areas. First, what it calls regulated assets, which are industries such as water and waste that have a good cashflow yield but perhaps slightly limited capital growth. Second, it looks for user pay assets, which include rail, ports, airports and toll roads where there are good growth characteristics.
Around the world, some of these businesses can be more integrated, such as in the US, whereas in the UK and Australia there tends to be a clearer separation. By mixing these two characteristics, you get a combination of elements of fixed interest and equities.
The fund is global but focuses on bottom-up analysis and cashflow rather than taking macro views. Fitch said it is no good merely looking at profits in the short term, since that does not tell you whether big amounts of capital will have to be employed in the future, for example, to build a new airport terminal.
In essence, what he favours are sustainability and predictability of cashflow. Within this, he can stress-test the business for environments where interest rates are going up or down and see whether this throws up any potential problems. There is therefore considerable diversity in the portfolio as different countries have different interest rate cycles.
I think it is fair to say that in the UK we are fairly advanced in infrastructure terms, so only around 5 per cent of the fund will be invested here.
A much bigger position will be in the US, which I was surprised to hear is chronically underinvested in many important areas and lags way behind most countries. You might imagine that this will be an emerging market portfolio but actually only around 10 per cent is positioned there.
Finding predictability of earnings in these regions is much harder because of the political as well as economic risks.
The total universe of stocks is around 700, which Macquarie cuts down to around 250 through a quantitative screening process that filters out small illiquid businesses. Of these 250, around 125 are actively monitored and a portfolio of some 40 to 50 is constructed.
The initial screen is quantitative but the final stocks for the portfolio are chosen as a result of qualitative analysis and company meetings as the team try to understand the latest trends and regulatory situations.
Emphasis is put on understanding the capital returns and the long-term capital requirements and cashflows of the business. The tendency is to run a buy and hold approach so a decision to sell is a big one. It is usually as a result of a major overvaluation in the market or fundamental change such as a takeover.
I suppose to some extent infrastructure projects have similar characteristics to commercial property. They generally have some predictability and are tangible, so benefits or otherwise can be seen. Nor do they have a direct long-term correlation with bonds or equities so some diversification is achieved.
Macquarie has achieved high double-digit returns and (again like commercial property) I think it would be dangerous to expect these to continue. I suspect something in the region of 7 to 10 per cent might be a better expectation.
The fund is not hedged which in itself could cause a problem if sterling continues to strengthen. However, with a big exposure to the US and the dollar at $2.04 to the pound, you are surely investing near the historic extreme of the range.
I have not made up my mind yet on infrastructure funds but they are an interesting development and one to keep an eye on. Macquarie has the sector to itself at the moment but I do not think it will be long before one or two others join the fray.
Mark Dampier is head of research at Hargreaves Lansdown