A noticeable rise in allocations to infrastructure over the past five years has been driven by investor search for yield, inflation hedging and low correlation with other asset classes. Commercial property has also proven to be a popular choice among investors due to its defensive nature, diversification benefits and income potential.
How do these asset classes offer value in a low-interest rate and highly volatile economic environment?
Commercial real estate
1. Consistent yield
Unlike companies that rely on profits to generate dividends for their shareholders, commercial real estate generates income by leasing space to tenants on contracted leases that typically last for more than 12 months. Therefore, income yield generated by this asset class is more consistent.
2. Indexed to inflation
Commercial leases typically incorporate annual, fixed or market reviews throughout the term of the lease, meaning that the rent is in many cases continually rising, helping to offset the effects of inflation over time. The rate of increase is negotiated with the tenant when a new lease is signed and the type of review is subject to market conditions at the time.
3. Price stability
Commercial real estate typically enjoys long cycles between downturns. Historically, 75% of the return on the investment has been generated from the yield rather than capital growth and is priced accordingly.
Infrastructure
1. Consistent yield
With cash expected to generate increasingly lower returns, infrastructure shares will continue to be an attractive way to access higher yields in a safe way. Infrastructure companies generate very stable cash flow each year and this allows them to pay out high and growing dividend payments to shareholders.
2. Flexibility
Global listed infrastructure plays many roles in an overall portfolio, such as diversification, relative value and liquidity. These characteristics are becoming increasingly recognised by sovereign wealth funds and pension funds globally, who are seeing global listed infrastructure as an important component of their overall infrastructure portfolio.
Global listed infrastructure plays many roles in an overall portfolio. We are seeing increased interest in listed infrastructure as people learn about the benefits it brings to a portfolio, such as diversification, stability and yield. Listed infrastructure allocations are increasing as investors allocate away from lower yielding bonds and also use this asset as safe bedrock to a global equity portfolio. These characteristics are becoming increasingly recognised by sovereign wealth funds and pension funds globally, who are seeing global listed infrastructure as an important component of their overall infrastructure portfolio.
3. Protection from interest rate hikes
Infrastructure companies tend to have long-term debt structures, and debt maturities can stretch out decades into the future. Typically, a large portion of the debt tends to be at a fixed interest rate and interest payments are therefore not sensitive to fluctuations in central bank rates.
Additionally, contracts and regulation are often negotiated on a ‘cost-plus’ basis, allowing charging structures to be increased in an environment of rising interest rates and inflation. If interest rates rise due to an increase in economic activity, then this provides natural economic support and an associated increased demand for infrastructure assets. Investors can choose to invest in infrastructure companies that have in-built protection through transparent regulation, or long-term contracts with high quality counterparties.
What are the risks for investors?
The overall scale of risk when investing in both commercial property and infrastructure sits between bonds and shares; the income is more secure but has less capital growth potential than shares.
Although the search for yield is a positive trend, where commercial property is concerned it is pushing prices ahead of rental growth. This could lead to pressure on property values for low rental growth assets when interest rates rise.
Within infrastructure, regulation and contract security are key areas for analysis. Regulation varies significantly around the world and can change, so understanding the different regulatory environments is very important. Similarly, understanding the contracts that infrastructure companies have is crucial to analysing the long-term value of a company.
Final thoughts
Typically, long-term investors like commercial real estate for the stability it provides in an investment portfolio, the long investment cycle periods and high potential to generate yield.
In a low interest rate environment where investors are chasing yield, asset classes that exhibit defensive and stable yield profiles, along with strong growth potential, are obvious candidates for a long-term investment strategy.
Source: AMP Capital
About the Authors
Tim Humphreys, Head of Global Listed Infrastructure
Tim is the head of AMP Capital’s Sydney-based Global Listed Infrastructure team. Tim has nearly 20 years of experience in the financial industry in the UK and Australia and also has a degree in civil and structural engineering.
Michael Kingcott, Head of Property Investment Strategy and Research
Michael is the head of the Property Investment Strategy and Research team, responsible for leading a team of property investment analysts who monitor and forecast the domestic and international property markets.
Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes 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 article 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 article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.
