Bridging the gap with infrastructure
The Fed has raised rates three times since December 2015 and despite being described as a ‘bond proxy’, while global bond values have declined, global infrastructure securities have continued to provide investors with positive absolute performance.
Global infrastructure continues to deliver with rising rates
YTD global infrastructure has returned 8.74% and delivered the 2nd best return outcome for investors compared to key mainstream asset classes.
Source: Bloomberg, as at 26 April 2017. Global Infrastructure = FTSE Developed Core Infrastructure 50/50 Hedged in Australian dollars; US Equity = S&P/ 500 Index TR converted to AUD; Emerging Market Equity = MSCI Emerging Market Equity NTR Index converted to AUD; Australian Equity = S&P/ASX 200 Accumulation Index; International Equity = MSCI World ex Australian NTR Index; International Fixed Interest = Bloomberg Barclays Global Aggregate Total Return Index Hedged to USD converted to AUD; Australian Fixed Interest = Bloomberg AusBond Composite Bond Index; Cash = Bloomberg AusBond Bank Bill Index Past performance is not a reliable indicator of future performance.
Performance of global infrastructure with recent Fed rate rises
It is common belief that when interest rates rise, income producing defensive assets such as infrastructure generally perform poorly. On the contrary, history has shown, as has this cycle, that global listed infrastructure securities can perform well after an interest rate hike.
Source: Morningstar Direct, Bloomberg
When the Fed started its interest rate hiking cycle in 2004 global infrastructure returned 33.41% in the following year. Even in the short-term, with expected price weakness, performance was 11.27% in the 4 months following the first 2004 rate hike and 10.89% after the first hike in December 2016.
Source: Bloomberg, Morningstar, Infrastructure Index is S&P Global Infrastructure Hedged to AUD Index and has been used as it has the longest calculation history. 4 Month period is 1 June 2004 to 30 September 2004 and 1 December 2016 to 31 March 2017. 6 Month period is 1 June 2014 to 30 November 2014. 12 Months period is 1 June 2014 to 31 May 2015. Past performance is not a reliable indicator of future performance.
One reason for this is because rising interest rates are generally an indication of a growing economy. Those infrastructure companies whose revenues are linked to consumer behaviour, such as railway operators and airports usually benefit from increased demand.
Another reason is infrastructure assets such as utility companies that provide electricity, gas or water, have earnings that are regulated based on their cost of capital. As the cost of capital rises so do their revenues.
A well-diversified portfolio of infrastructure securities will therefore include both:
companies with a hedge against rising interest rates; and
companies that will benefit from a rising rate environment.
Global fiscal policy will see a significant uptick in infrastructure investment
- According to a 2016 report “Failure to Act” by the American Society of Civil Engineers, the US needs to spend US$3.3 trillion on infrastructure and Trump has committed to infrastructure spending.
- The additional benefit of infrastructure investment for governments is that it creates more jobs, stimulating economic growth and promoting higher living standards.
- Globally a number of nations are increasing infrastructure investing. Japan for instance has invested US$100 billion for roads, bridges and railways. China has stated it will put billions into the ‘Silk Road’ infrastructure project connecting Asian economies.
Bridge the gap in your client’s portfolio by adding global infrastructure
The Sharpe ratio provides a measure of risk-adjusted performance by combining a return measure with a volatility measure to quantify the relationship between the returns and risk. The chart below shows the impact on returns and Sharpe ratio by adding infrastructure to a typical Australian balanced portfolio as outlined by the MoneySmart Balanced portfolio (Portfolio A).
* Portfolio A based on MoneySmart Balanced portfolio
Source: Morningstar Direct, Five year performance 1 March 2012 – 28 February 2017 .Results are calculated monthly and assume immediate reinvestment of all dividends. You cannot invest in an index. Past performance is not a reliable indicator of future performance. Indices used to approximate investments Cash – RBA target cash rate, International Bonds – Barclays Global Aggregate Bond Index A$ Hedged , Australian Bonds – Bloomberg AusBond Composite 0+ years, Infrastructure – FTSE Global Core Infrastructure 50/50 Index Hedged AUD, International Equities – MSCI World ex Australia Index , Australian Equities – S&P/ASX 200 Accumulation Index,
The above results show that compared to a typical portfolio with no exposure to infrastructure, a 5%, 10% or 15% allocation to global infrastructure over a five year time period would have:
increased returns; and
increased the Sharpe ratio of the portfolios, delivering a better risk/return trade-off.
Infrastructure assets have also demonstrated lower volatility and a low correlation compared to traditional asset classes.
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