As the threat of global inflation grows, it's time for investors to consider the impact that inflation can have on their portfolios.
In the current environment, the inflation-hedging benefits found in global infrastructure can become even more appealing, particularly within a diversified portfolio that includes exposure to asset classes that are typically more impacted by inflation.
Global infrastructure assets are tangible, physical assets with inelastic demand and monopolistic profiles. These essential assets benefit from contractual or regulatory driven, inflation-linked revenue growth. Moreover, the companies benefit from earning a regulated return on capital expenditures needed to upgrade and enhance existing infrastructure assets. The combination of organic inflation-linked revenue and regulated investment returns is an operating earnings growth that far outpaces inflation.
Inflation-Linked Revenue Growth
- Asset Profile
Global infrastructure asset owners can pass through the effects of inflation via higher prices. For example, toll road assets may offer inflation protection as contracts typically tie tariffs explicitly to inflation. In other instances, such as regulated utilities in the U.K. and Italy, regulated returns are set based on real returns, which take inflation into account rather than nominal returns, again allowing for a direct link to inflation. In most jurisdictions, regulated returns are set with reference to the risk-free rate, which is itself a function of inflation.
- Investment Growth
In addition to inflation-linked revenue, global infrastructure companies grow earnings and dividends through capital investments to upgrade, improve, or enhance their existing infrastructure assets. Such spending offers them an opportunity to earn a rate of return on these investments in excess of their cost of capital, which drives cash flow growth. In most instances, the investments are undertaken with a known regulated return; the regulated return takes inflation into account and is at a spread to the companies’ cost of capital.
CBRE Clarion Global Infrastructure Universe
In a rising inflation environment, infrastructure assets offer hedging benefits:
- Regulated assets: Regulators set allowed returns with reference to the risk-free rate, so returns increase when bond yields rise to reflect higher inflation expectations
- Concessions assets: Typically have inflation linked tariffs coupled with some level of demand risk (i.e. higher volume leads to growth in revenues)
- Monopolistic assets: Some types of infrastructure have limited or no competition and have demonstrated pricing power
Stable Cash Flows
Some of the key features of global infrastructure are the inherent high barriers to entry and often difficult-to-replace physical assets that are essential for society to function. These assets typically benefit from monopolies and inelastic demand, which is the source of their stable cash flows over long periods of time. Global listed infrastructure has historically generated relatively predictable and rising cash flows, which has led to strong dividend growth across market cycles and through various macroeconomic events. This means global infrastructure is less affected by macroeconomic activities, such as inflation and rising interest rates, and economic cycles compared to other investments.
Operating Earnings Growth Comparison
Incorporating global listed infrastructure into a mixed-asset portfolio may provide an attractive combination of inflation-linked revenue growth and rising cash flows. At CBRE Clarion*, we incorporate inflation directly into our assessment of each company, based on their assets, contracts and location. We believe our global infrastructure resources combined with our high-conviction and risk-conscious investment process, enhances our ability to generate out-performance while capturing the stability, income, and growth potential of listed infrastructure.
More Property and Infrastructure articles
This website is intended for persons resident in Australia only and should not be relied upon by persons from any other jurisdiction. UBS Asset Management (Australia) Ltd ABN 31 003 146 290, AFS Licence No. 222605 is the product issuer of investment funds listed on this website. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation or needs. Any potential investor should consider the relevant product disclosure statement (PDS) in deciding whether to acquire, or continue to hold units in a fund. Please consult your financial adviser. Past performance is not a reliable indicator of future performance.
Offer not to persons outside Australia
The PDS does not constitute an offer or invitation in any jurisdiction other than in Australia. Applications from outside Australia will not be accepted through the PDS. The funds are not intended to be sold to US Persons as defined under Regulation S of the US federal securities laws.
© UBS 1998 - 2020. All rights reserved