- In the current economic environment, solid GDP growth and increasing inflation expectations are putting pressure on central banks to raise interest rates.
- Although rising interest rates negatively impact infrastructure returns, faster GDP growth and rising inflation are both positive for infrastructure performance. We would therefore expect a moderate rise in interest rates to be largely offset by accelerating GDP growth or higher inflation.
- Infrastructure returns in periods of rising real interest have historically been below average (-12% p.a. versus 2004-17 average); however, returns remained positive at 10.1% p.a.
- Infrastructure owners have been putting long-term facilities in place to lock-in low financing costs. This is a structural change from previous cycles that could mitigate the impact to the sector of rising real rates.
- Infrastructure is often referred to as a bond proxy. During 2004-2017, infrastructure performed best relative to listed equities when either GDP growth was below average or real interest rates were falling; this is also when bond returns performed best.
- The bond-like features of infrastructure, combined with the yield pick-up versus fixed income, were key factors supporting the significant inflows into the asset class over the past decade. During 2004-17, listed equities outperformed infrastructure when real rates were rising or GDP growth was above average. Investors' appetite for additional infrastructure allocations in such environments could be reduced.
How will infrastructure returns perform as rate rises?
This is not a straightforward question to answer. It depends on whether we refer to the performance of the cashflows, i.e. absolute performance or the attractiveness of the sector relative to other asset classes.
We apply a three-pronged approach to provide some insights.