Appeal of infrastructure

Cash flows from this asset class are more sustainable and predictable

By: Michael Nairne
May 21, 2015 October 30, 2019
23:00

The client base of many financial advisors is undergoing a sea change as aging baby boomers swell the ranks of retirees. The challenge for financial advisors is shifting from investment strategies designed to create wealth from ongoing savings to strategic asset mixes designed to fund decades of retirement spending reliably.

Canadian pension funds have been grappling with this issue for years and, in response, are global pioneers in infrastructure investing.

Infrastructure consists of the physical structures and facilities that underpin the basic services of a society. These can be broadly grouped into transportation (e.g., airport, toll roads and ports), power and energy (e.g., utilities and pipelines), communication (e.g., cellphone towers) and social (e.g., prisons and hospitals).

As an asset class, infrastructure possesses a number of appealing characteristics. Because the demand for infrastructure services is quite inelastic to price changes and supply often is monopolistic or subject to limited competition due to high barriers to entry, cash flows from infrastructure assets are more sustainable and predictable. The essential nature of the services provided makes infrastructure assets less subject to the business cycle and more defensive in nature. The long life cycles of these assets make them an attractive option vs long-term bonds in terms of matching retirement liabilities and acting as a hedge against inflation.

According to the Pension Investment Association of Canada, Canadian pension plans increased their allocation in infrastructure to 5% of assets in 2013 from 2.4% in 2006. However, many plans have even higher allocations. The Canada Pension Plan has a 6.1% allocation, while the Ontario Municipal Employees Retirement System, one of the early movers into this asset class, has a 14.7% allocation.

Infrastructure investments are available in both private and publicly traded markets. Regarding the latter, the S&P global infrastructure index (SPGII) had an annualized Canadian-dollar return of 9.6% from December 2001 to March 2015, far outpacing the 6% return of the S&P global broad market index (SPGBMI) over the same period.

The volatility of the SPGII also was slightly lower – its annualized standard deviation was 12.4% vs 12.9% for the SPGBMI. More important, the SPGII’s downside performance was superior – the average drawdown was minus 6.1% vs minus 9% for the SPGBMI; the SPGII’s maximum drawdown during the credit crisis was minus 38.7% vs minus 43.4% for the SPGBMI.

The fundamentals of the SPGII are relatively attractive. As of March 31, its price/forward earnings ratio was 8.5, its price/cash flow ratio was 9.4 and its dividend yield was 3.5%. In comparison, the SPGBMI had a price/ forward earnings ratio of 17, price/cash flow ratio of 13 and a dividend yield of 2.3%.

Michael Nairne is president of Tacita Capital Inc. of Toronto, a private family office and investment-counselling firm. The company, its principals, employees and clients may own securities mentioned in this article.