Infrastructure assets produce good returns as interest rates rise, says RARE


A standard piece of investment commentary – that ‘infrastructure assets are ‘bond proxies’ and will perform poorly when interest rates rise’ – is an overly simplistic view of the asset class and its dynamics says RARE, a leading global listed infrastructure fund manager.

This issue has had plenty of airplay since December last year, when the US Federal Reserve raised its target funds rate by 25 basis points. The Fed raised rates again in March and in June.

“You have to look at what is causing rates to go up says Steve Williams, RARE Infrastructure’s Head of Australian Retail. If they are being driven up by increased economic activity, user-pays assets can benefit.

“For example, as economies grow, rail companies will benefit as they are required to move more goods across their networks, and this will offset the impact of the rise in interest rates.”

“The important question is whether the underlying cash flows from the infrastructure business are impaired in a rising rate environment.”

Investment management researcher Morningstar supports this view. In a recent report, it pointed to the fact that the S&P Global Infrastructure Index has risen more than 10 percent over the past 12 months, despite the Fed’s tightening of monetary policy.

“One reason for this is that rising interest rates may be an indication of a growing economy. Infrastructure companies that are linked to consumer behaviour usually benefit from increased demand,” Morningstar says.

History has shown that global listed infrastructure securities can perform well after an interest rate hike. Long-term expectations of future interest rate rises will often be incorporated in bond pricing well ahead of the actual rate decision.

“At RARE, we seek an infrastructure return rather than an equity return, so a total return of 8 to 10 percent is a more realistic target through a cycle” commented Williams.  “All of our four funds are benchmark unaware and have an absolute return focus.”

There are a couple of local listed infrastructure companies in the fund, including Spark Infrastructure, which holds a portfolio of electricity, gas, water and sewerage businesses, and AusNet Services, an electricity transmission company.

“The companies we invest in must meet three key criteria explained Williams: “Firstly, the asset that the company owns must be a hard, physical asset. Secondly, this hard asset must provide an essential service to society or an economy, and finally, there must be robust frameworks in place to ensure that we, the equity holders of these companies, get paid. This framework can be regulatory in nature or based on long-term concessional contracts. Both structures provide visibility over the company’s ability to generate cash flow”.

“Most regulators allow utility operators to pass on the rise in the cost of capital, so rising rates do not have a major impact on the long-term valuation of assets. However, when rates do rise shorter term share market investors tend to reduce their utility holdings. As long-term investors, RARE views rising interest rates as an opportunity to buy solid companies with attractive cash flows.  We saw this play out in 2016.”

RARE infrastructure was established in 2006 and offers Australian investors four funds all investing in global listed infrastructure assets;

  • The RARE Infrastructure Value Fund – Hedged (ARSN: 121 027 709)
  • The RARE Infrastructure Value Fund – Unhedged (ARSN: 150 677 017)
  • The RARE Infrastructure Income Fund (ASRN: 132 182 631)
  • The RARE Emerging Markets Fund *ASRN: 132 182 462)

As global investors, there is greater opportunity and flexibility when investing in listed companies, as not all markets have simultaneously rising rates or may be in a different part of their economic cycle.

The RARE Infrastructure Income Fund, which targets a net distribution yield of +5 percent a year, produced an income of 5.2 percent over the 12 months to the end of August 2017 and a total return of 14.1 percent.

Over a five-year period, the Fund delivered 13.3% net of fees.*

 *Past performance is not a reliable indicator of future performance.

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