Infrastructure

Why Active Management Matters for Listed Infrastructure

Article

Sep 12, 2022

Investor interest in listed infrastructure has increased dramatically in recent years, with growing recognition that the asset class can potentially play a meaningful role in client portfolios. The inability of government budgets to fund much-needed spending on infrastructure has created growing opportunity for investors to potentially benefit from the favorable characteristics of the asset class. These attributes include the potential for consistent long-term cash flows, inflation protection mechanisms and a favorable risk/return profile.

We believe the long-term outlook for global infrastructure equities is attractive. While listed infrastructure can be accessed through passive and active approaches, our view is that capturing the evolving asset class’s exciting opportunities, and portfolio benefits, requires an active manager. Here’s why.

Active managers understand how diverse infrastructure is. Infrastructure is not a clearly defined asset class, though it commonly is viewed as consisting of the companies that own and operate the assets that form the backbone of the global economy. We approach infrastructure from this perspective and view the asset class as comprising four core sectors of companies that provide infrastructure products and services: transportation, energy infrastructure, utilities and communications.

These infrastructure sectors are composed of diverse industry groups, each with distinct fundamentals and macroeconomic sensitivities (e.g., responses to economic activity, interest rates and inflation). In addition, even within these industry groups, the characteristics of individual companies and assets vary, especially across geographies.

These differences help explain the wide gaps and shifting winners and losers we observe in historical infrastructure index returns. Active managers can potentially take advantage of the diverse nature of infrastructure. They can use their research expertise and deep understanding of fundamentals to figure out which companies offer the best value opportunities, due to market mispricing, and adjust portfolios accordingly.

Infographic for accessing the overall risk and return profile of a given infrastructure

Active managers can navigate the varied global regulatory environment. Infrastructure regulations, policies and politics can vary by country—and even by locality—introducing additional complexities to the infrastructure universe. These geographical differences may provide value opportunities for active investors who can leverage their global perspective and in-depth research to understand, and properly price, such risks across jurisdictions.

For instance, we are closely watching the potential impacts of a gas shortage on European utilities. Some companies may be contractually obligated by local governments to provide gas, regardless of the source, while some may face “windfall taxes” on profits derived from high power prices. Such price impacts may negatively affect earnings, and they have already weighed on the equities of European utilities. Yet these regulations are unlikely to be uniformly imposed across Europe, creating potential opportunities for active managers who can properly price risk and take advantage of value-driven opportunities arising from geographical differences.

Another example related to regulations already in place: water utilities. At first glance, water assets appear to be relatively straightforward—delivering water via a network of pipes. Beneath the surface, however, there are differences in the regulations that govern water utilities across the globe. Take the U.K. and the U.S. In these two regions there are key regulatory differences, including regarding how increases in inflation impact the allowed rate of return utilities can earn, and in the U.S. regulations vary even between states. Passive exposures allocate to all water utilities in their benchmarks regardless of the market scenario. In contrast, an active manager can tactically adjust exposures based on an in-depth understanding of how the regulatory nuances may impact individual water utilities in different market conditions.

Active managers can look beyond benchmarks. Active managers do not have to be benchmark- constrained. They can take a dynamic and flexible approach to uncover new opportunities that may not be included in traditional infrastructure benchmarks but have strong growth prospects as the asset class continues to evolve.

How the world works is continually evolving, and infrastructure adapts with it. By using an in-depth process to understand changing business models and regulatory environments, an active manager can spot emerging opportunities that have characteristics similar to traditional infrastructure. One such example we see currently: waste-management companies, which we believe are poised to benefit as the global economy shifts toward a greener “circular” model. These companies tend to share many characteristics with infrastructure companies, including monopolistic business models, steady cash flows and long-term contracts with inflation escalators built in. Active managers can seek to capture such outside-the-benchmark opportunities.

Active managers can outperform. Active managers have historically outperformed their passive counterparts over the short, medium and long terms. We attribute this outperformance to active managers’ ability to capitalize on the heterogenous nature of infrastructure, and market inefficiencies and temporary dislocations, to find opportunity and tactically adjust portfolios accordingly.

Analysis of active listed infrastructure funds

Active managers can be defensive. Listed infrastructure exposures have historically performed relatively well vs. broader markets during down markets. We believe this is due to infrastructure companies’ unique characteristics, including long-term contracted cash flows, monopolistic business models with high barriers to entry, and inelastic demand. Active managers, however, have historically been even more defensive during down markets, given their ability to be tactical. While passive exposures reflect their benchmarks regardless of market conditions, active managers can perform in-depth due diligence to determine which companies may provide the best risk-reward profile in a given market scenario and allocate accordingly.

Analysis of active funds can be more defensive than passive exposures

We believe capturing the advantages of active management and potential outperformance and capital preservation possibilities requires an active manager with the right ingredients. Key recipes for success include a dedicated focus on the infrastructure asset class, deep expertise in fundamental research, extensive company engagement, and a global owner-operator perspective.

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Disclosure Information

RISK DISCLOSURES

There are risks involved with investing in Listed Infrastructure, including possible loss of principal. Infrastructure companies may be subject to a variety of factors that may adversely affect their business, including high interest costs, high leverage, regulation costs, economic slowdown, surplus capacity, increased competition, lack of fuel availability and energy conservation policies.

IMPORTANT DISCLOSURES

This material is not, and is not intended as investment advice, an indication of trading intent or holdings or the prediction of investment performance. All information is current as of the date of this material. Views and information expressed herein are subject to change at any time. Brookfield Public Securities Group LLC disclaims any responsibility to update such views and/or information. This information is deemed to be from reliable sources however, Brookfield Public Securities Group LLC does not warrant its completeness or accuracy. This presentation is not intended to and does not, constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, product, investment advice or service (nor shall any security, product, investment advice or service be offered or sold) in any jurisdiction in which Brookfield Public Securities Group LLC is not licensed to conduct business and/or an offer, solicitation, purchase or sale would be unavailable or unlawful. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.