Emerging market infrastructure presents rare opportunities

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Emerging Market infrastructure equity returns significantly higher than those of Developed Market infrastructure.

Emerging Market (EM) infrastructure equity returns are significantly higher than those of Developed Market (DM) infrastructure companies according to research by leading listed infrastructure manager, RARE Infrastructure.

While the value of EM infrastructure is expected exceed DM infrastructure by 2030, the annualised total return – dividends plus share price growth – of EM utilities is 9.62% p.a. versus 7.74% p.a. for DM utilities, according to RARE’s research of listed infrastructure covering the ten-year period ending 30 January 2018.

The weighted average annualised dividend return during this period of the two asset sectors slightly favours DM with 4.5% p.a. versus the EM figure of 4.35% p.a.

“However, the weighted average annualised price return (share price change) during this period markedly favours EM utilities 5.27% p.a. compared to 3.24%p.a., making EM the clear winner in total return terms,” says Charles Hamieh, portfolio manager at RARE Infrastructure.

He says: “EM securities offer a great source of income and capital growth in returns plus regional differentiation, making them a compelling portfolio option for many investors who are not perturbed by a slightly higher volatility profile of this asset sector.

“Companies with long track records of stable, growing earnings can suit the defensive investor seeking income from their assets. If the end investor also seeks lower volatility for their investments, then regulated infrastructure companies in developed markets (DM), with tried and tested regulation, may suit even better,” says Hamieh.

“Proven regulation is more commonly found in developed markets for infrastructure stocks such as water, gas and electricity companies. As such, creating a portfolio of developed market infrastructure companies chosen for their likelihood of offering sustainable growth in income and capital is logical.

“However, emerging markets (EM) by their very nature are changing rapidly and to exclude stocks from such countries can limit diversification opportunities.

“Countries such as Brazil have robust regulatory frameworks for utility companies that are comparable to developed countries.

“Yields can be higher for EM utilities too, as their revenue is often indexed to local inflation and base rates.

“So, by widening the opportunity set to include EM listed infrastructure within agreed limits, investors can broaden the growth and yield profile of their investment, as well as diversify their regional exposure,” Hamieh notes.

Another positive factor in relation to EM infrastructure is comparative economic growth rates of EM economies versus DM economies.

“EM infrastructure looks to have a long market cycle ahead of it, as expanding economies put in place plans to create greater supplies of water, energy, roads and communications.

“This is being driven by urbanisation and much higher rates of growth than developed markets,” said Hamieh.

The International Monetary Fund forecasts (IMF World Economic Outlook Update, January 2018) the gross domestic product of emerging market countries to rise from 4.7% in 2017 to 5% in 2019.

By contrast, developing countries are expected to grow by only 2.2% in 2019, a fall from 2.3% in 2017.

“The two offsetting factors when considering the attractions of EM infrastructure investing are potential currency fluctuations and potentially higher volatility of EM infrastructure stocks versus their DM counterparts.

The standard deviation of the MSCI Emerging Markets Index (USD) is 22.6% over 10 years to the end of January 2018, while for the MSCI World it is 16.2%. However, some investors are willing to take on the risk necessary to receive the potential rewards on offer in these markets.

“We believe the message for investors seeking greater returns and regional diversification is straight forward.

“Carefully selected emerging market stocks, when blended into a portfolio of global listed infrastructure stocks, can offer a greater source of income, returns and diversification. They also help diversify risk and widen the opportunity set giving the potential for greater risk-adjusted returns,” Hamieh said.

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