Boring and unsexy do not mean unattractive
Societies’ essential services represent uncorrelated returns for investors
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Water and sewage. Railroads. Bridges.
These are not sexy. One might even say they’re boring.
In the world of investing, however, unsexy and boring do not necessarily equal unattractive.
Today, we’re exploring an asset class that’s on the receiving end of hundreds of billions of dollars in investments over the next decade courtesy of a $1 trillion bipartisan bill.
If you haven’t guessed by now, we’re talking infrastructure.
What are infrastructure assets – exactly?
In short, they’re tangible assets that provide critical services at scale.
They serve as the foundation that modern societies run on–the literal plumbing.
The range of services provided varies widely, from social–like hospitals, schools, and libraries–to communications–like deep-sea cables, fiber optic networks, and data centers.
Airports for planes to fly into. Roads for cars and public transit systems to operate on. Those public transit systems.
They power cities with energy of all kinds–oil & natural gas, thermal, and other renewables–and develop real estate for people to live on and businesses to headquarter at.
Infrastructure assets are why water comes out of your faucet and the reason you’re not forced to use an outhouse.
Like I said, the literal plumbing.
Characteristics of infrastructure assets
All of the services listed above are not just important to society–they’re essential.
Cities and towns simply must have bridges that are upright and clean drinking water.
That remains true whether the markets are booming or busting which makes them resilient to economic cycles.
Their necessity means they aren’t driven by the same factors as public equity and private debt markets which lends itself to a low correlation to traditional assets.
But just because they’re essential it doesn’t mean they’re easy to provide.
The specialized technical knowledge and expertise required to deliver these complex services on such a vast scale are extreme. That poses a barrier to entry for competition.
This gives infrastructure assets a quasi-monopolistic nature.
Given their scope and scale, investments in infrastructure require long time horizons–5, 10, 15, even more than 20 years–and they are relatively inaccessible as compared to other alternatives.
These factors make for an illiquid asset class.
Boring and unsexy has its advantages
Boring as a railroad or bridge may be, they are real, tangible assets that provide necessary operations for a functioning society.
Their usage and adoption create a network effect wherein the more people consume the service, the more important it becomes to society.
As such, they carry irreplaceable intrinsic value.
Infrastructure assets will often come with regulated and contracted revenue models built into long-term–sometimes decade-long–contracts.
While returns are also generated via capital appreciation, these assurances make way for stable and predictable cash flows.
Many of these long-term contracts will also include innate inflation linkage which serves as protection against rising prices and allow for the potential for real returns.
As for those returns, investors who have been willing to dig in for the long haul have been rewarded handsomely relative to US and global stocks, real estate, and natural resources.
But boring doesn’t mean without risk
The $1 trillion bill passed in 2021 is the largest piece of US infrastructure legislation since 1956 when Dwight D. Eisenhower decided to equip the country with an interstate highway system.
That same interstate highway system is the one being used today (with some upgrades, obviously).
The magnitude of the bill is telling – infrastructure is very capital-intensive.
This means that assets are exposed to debt/leverage which is affected by fluctuations in interest rates.
Higher rates lead to higher interest payments lead to lower returns.
Because of the intertwined nature of infrastructure and the economies in which they exist, political and regulatory instability also pose risks, especially for assets in developing and emerging markets.
In these cases, civil unrest or a change in leadership can be enough to disrupt operations.
That leads me to the final primary risk for this asset class: technological disruption.
We noted that infrastructure services require complex expertise. The same can be said of the technology used to provide them.
Both are typically cutting edge…until they’re not.
Advancements and rapid changes in new tech mean current systems have the potential of being rendered technically obsolete.
As an (admittedly long-term) example, consider the ongoing transition from current energy infrastructure systems–with their reliance on carbon-intensive sources like oil and natural gas–to renewables like wind, solar, and nuclear.
Investing in infrastructure
As I mentioned, infrastructure assets require significant capital outlays, more so than most other traditional asset classes.
That means investing in them–even for institutional investors–is not as easy as entering a trade or picking up the phone to dial a broker.
Unfortunately, infrastructure as an asset class is still not particularly accessible for retail investors.
Listed funds: publicly traded mutual funds and ETFs are the simplest way for investors to gain exposure to infrastructure. These funds off broad and specialized categories as well as liquidity (something that’s otherwise lacking within the asset class).
Private equity funds: many infrastructure projects are financed through private/public partnerships. PE funds leverage their unique ability to raise vast amounts of money to connect these parties and take ownership in the projects.
Private debt funds: similar to PE funds and only available for accredited investors, infrastructure debt funds focus on financing essential projects and generating returns on debt payments. This makes them slightly less risky than their equity counterparts and allows for more stable cashflows.
Wrapping up…
Infrastructure may not be sexy.
It might be boring.
But it’s essential.
Their necessity makes them resistant to economic cycles and their complexity creates a natural barrier to entry for competition.
For investors (who are able to access it), the asset class represents the potential for predictable, long-term returns with little correlation to traditional markets.
As always, DYOR (do your own research)!!
Until next time…
-Genevieve Roch-Decter
Sources
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