4 AUGUST 2016
EDITION 25
Infrastructure investing in a world of low interest rates
Key points
> Infrastructure offers attractive yield and inflation based
returns, providing a relatively low correlation to shares
and bonds.
> With ultra low bond yields and equities limited by
constrained growth prospects, infrastructure, particularly
on an unlisted basis, is attractive for investors looking to
diversify their portfolios.
assets often with a life of 30 or more years, and can benefit
from significant barriers to entry, a dominant market position
and relatively predictable cash flows and operational risks. The
predictability of cash flows is because consumer demand for
their services is usually stable, growth in infrastructure tariffs is
often regulated to link to the rate of inflation, huge capital
requirements provide barriers to entry, operating costs are
usually low and payment or credit risk is low. This results in the
following characteristics:

A relatively high income yield contribution to total return.
Depending on the type of infrastructure asset, income yields
can vary from around 3% for a growth asset such as an
airport, with a total return of 10%-15%, to a yield only total
return of 7%-9% for social public private partnerships
(PPPs). This is high in a world where government bond
yields range from just below zero to around 2%.

A moderately low level of volatility, reflecting relatively
steady earnings or cash flows often linked to inflation and
periodic appraisal based valuations.

A relatively low correlation with bond and equity markets. By
having assets in an investment portfolio that have low
correlations with other assets, the riskiness of the portfolio is
reduced via diversification.
Introduction
Infrastructure is seeing solid interest from investors. Not only
does it offer relatively attractive yields and return potential, it’s
also a good diversifier. With ultra low bond yields and equities
limited by constrained growth prospects, infrastructure can
provide a source of relatively stable returns underpinned by
reasonable yields and inflation linked revenues. This note
reviews the key characteristics of infrastructure and its role in a
diversified investment portfolio.
Infrastructure – what is it?
Infrastructure refers to assets used to satisfy general
community, societal and economic needs and underpins the
operation of society. These assets include utilities (electricity
generation, transmission and distribution, telecommunications,
gas and water distribution), transport infrastructure (toll roads,
rail, airports and ports) and social infrastructure (such as
schools, hospitals, prisons and public housing). The broad
range of infrastructure assets means that it is not a generic
asset class. It encompasses lower returning, lower risk social
infrastructure through to regulated utilities and demand based
infrastructure such as ports, airports and telecommunications.
Infrastructure assets typically follow a lifecycle that see them
start off as greenfield assets where yield is low but capital
growth is high, through to mature assets where yields are high
and growth potential is more in line with the economy. As such
infrastructure assets are subject to different risks at different
stages of their lifecycle. Most investors are reticent to accept
greenfield risk, where demand may not be assured.
Consequently, many investors focus on mature operational
assets, where patronage has already been proven.
There is only a limited number of unlisted infrastructure funds
with a long return history available, but the table below provides
a rough guide to the performance history of unlisted
infrastructure. It can be seen that unlisted infrastructure has
provided solid returns, but with a modest level of risk (as
measured by standard deviation). It can also be seen that
unlisted infrastructure has a relatively low correlation with most
assets, suggesting that it is a good diversifier and will help
smooth out a portfolio in times of turbulence in equity and bond
markets.
Infrastructure – past returns, risk and correlations to other
assets, September 1995-June 2016
Return,
Risk,
Correlation*
%pa
standard
with
deviation
infrastructure
Infrastructure ^
11.8
8.6
1.00
Aust shares
8.8
15.0
0.37
Prior to the late 1980s most infrastructure assets, particularly in
Australia and Europe, were owned by governments. Since then,
the desire to reduce public debt and a focus on efficiency have
seen a shift towards private sector ownership.
Global shares
6.2
18.6
0.33
Unlisted property
9.4
5.5
0.47
Characteristics of infrastructure assets
^ The AMP Capital unlisted Diversified Infrastructure Trust, which commenced in
September 1995, has been used as a proxy for unlisted infrastructure. * A
correlation coefficient ranges between +1 (meaning that returns move precisely
together) and –1 (meaning that two assets move perfectly in opposite directions).
Source: Thomson Reuters, AMP Capital
Infrastructure investments typically have high upfront capital
commitments but low operating costs. They are long duration
Aust fixed interest
7.0
3.7
0.03
Cash
5.0
1.4
-0.15
Prospective returns
Going forward, infrastructure returns are likely to be lower than
they have been. As investor demand has been strong in
response to falling interest rates and bond yields and a broader
search for yield, many infrastructure assets are being acquired
on more expensive valuations. This has led to lower return
potential going forward. However, notwithstanding this,
infrastructure remains attractive compared to the low returns on
offer from bonds and cash. The next table provides a rough
guide to prospective returns and risk for unlisted infrastructure
versus other assets, over the next 5 years.
Indicative yields, returns (pre tax and fees) and risk
Project type
Income
Projected
yield, %
return, %pa,
Risk
next 5 yrs
Medium
infrastructure is a bit like comparing listed and unlisted
property. Some fund managers also offer funds investing in
both listed and unlisted infrastructure.

Debt based funds. These include investments in
infrastructure debt (eg, debt issued by electricity distributors)
– but at least for non-institutional investors this usually
entails investing in funds with general corporate debt as
well. This has the characteristics of debt investments.
Australia’s infrastructure deficiency
In common with most of the developed world, Australia is faced
with an infrastructure deficit, which has the potential to
negatively impact economic growth in the long term if not
addressed. Public investment has tended to be limited by
budgetary constraints and private investment has not filled the
gap. An issue has been that a successful risk sharing model
between the public and private sectors to accommodate
greenfield demand risk has yet to evolve. Australia seems to be
moving to an approach that would see public sector
development of higher risk infrastructure assets, with
subsequent sale to the private sector after demand is proven.
The sale proceeds would then be recycled into new
developments. Australia also has some of the best prospects
for further privatising remaining publically owned utilities, in
contrast to most other developed countries.
Infrastructure
5.5
9.0
- Airports
3-5
10-15
Medium
- Toll roads
6+
9-10
Medium
- Electricity/gas distrib
5-6
7-9
Medium
- Social Infrastructure
7-9
7-9
Low
- Ports
4-6
8-10
Medium
- Rail
5-8
10-12
High
Aust shares
4.6 *
7.9
Med-High
Global shares
2.5
8.2
Med-High
Unlisted property
6.0
8.0
Medium
However, in a global context, the absence of a strong pipeline
of investable projects, high institutional appetite for mature
assets and constricted supply will continue to drive up prices.
Listed property
4.4
6.7
Medium
Role of infrastructure in a diversified portfolio
The average exposure of Australian superannuation funds to
infrastructure is around 2-4%, but this masks a wide range from
zero to over 10%. Trading off expected returns, risk and
liquidity, a balanced investment portfolio could justify up to 10%
exposure in infrastructure depending on the allocation to
unlisted property. The ideal allocation tends to rise as the risk
profile of a diversified portfolio increases. One way to overcome
the illiquidity associated with unlisted infrastructure is to
consider a mix of listed and unlisted infrastructure. The
infrastructure allocation should arguably come from a
combination of bonds and equities. In the case of bonds, it is
notable that infrastructure, like property, shares similar
characteristics in terms of a yield focus and a low correlation to
shares. So with bond yields being very low, there is clearly a
case to consider infrastructure as a partial alternative. But this
shouldn’t be taken to an extreme - given government bonds
have zero (or at least near zero) “default” risk in contrast to
infrastructure.
Aust fixed interest
1.7
1.7
Low-Med#
Cash
2.7
2.7
Very Low
* Pre franking credits # Ultra low bond yields suggests that the risk for bonds may
no longer be low – but that’s a separate issue! Source: AMP Capital.
The combination of relatively steady and attractive returns and
a relatively low correlation to financial assets make unlisted
infrastructure attractive for investors. Of course, a risk to
infrastructure investments given their yield characteristics is a
sharp rise in interest rates and bond yields. So far there is little
sign of this, but its one factor investors must keep an eye on.
Accessing infrastructure investments
There are various ways of investing in infrastructure, via:



Unlisted infrastructure funds. These are a bit like unlisted
property funds and invest in a diversified range of
infrastructure assets/projects. As they access infrastructure
projects directly, they have the investment characteristics
noted above, including low volatility and a low correlation
with equity and bond markets. But they have relatively low
liquidity, and are dependent on the fund manager getting
exposure to assets (often by bidding for large public assets
or projects). Several fund managers offer unlisted
infrastructure funds, which can have a country-specific,
regional or global focus. Traditionally unlisted infrastructure
has only been available to institutional investors, though
some fund managers have developed products offering
unlisted infrastructure exposure to retail investors.
Investing directly in listed infrastructure shares, such as
Transurban and AGL. Since these are listed on the share
market they are more volatile and can lead the performance
of unlisted infrastructure.
Conclusion
Infrastructure provides an attractive investment, offering solid
yield based prospective returns and a relatively low correlation
to shares making it a good diversifier. With ultra-low bond yields
and shares constrained, and the likelihood that we will see
continued higher than normal volatility in share markets,
infrastructure, particularly unlisted infrastructure, is likely to play
a rising role in investors’ portfolios.
Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital
Listed infrastructure funds. These are now offered by a
large range of fund managers and invest in a portfolio of
listed infrastructure shares either in Australia or globally or
both and hence provide easier access to infrastructure
investments, liquidity and greater diversification because
they can be exposed to a broader range of infrastructure
assets than unlisted funds. On the down side they come
with higher volatility and have a higher correlation to shares
(as they are listed). Comparing listed and unlisted
Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds
Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation,
any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account
of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this
document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.