Higher inflation and interest rates will have little impact on the valuations of regulated infrastructure assets, and some assets should see cash flows increase with upswing in economic growth, leading infrastructure asset manager ClearBridge Investments has forecast.
As investors assess the outlook for inflation and the impact of higher interest rates on their portfolios, ClearBridge Investments says there appears to be little or no correlation between various listed infrastructure assets and movements in inflation over the past 30 years.
In recent central bank commentary, Federal Reserve Chairman Jerome Powell said inflation has come in ahead of expectations and could end up higher than the Fed’s current forecast of 3.4% for 2021 – up from 2.4% forecast three months ago. Powell also said the Fed expects to start raising interest rates next year, with two increases by 2023 anticipated.
Reserve Bank of Australia Governor Philip Lowe said he expects the June quarter consumer price index to rise temporarily above 3.0% due to the unwinding of some pandemic-related price reductions. But beyond that point, inflation pressure will be subdued, according to the Reserve Bank of Australia.
Portfolio Manager Shane Hurst from ClearBridge Investments says: “Looking ahead, we are constructive on a global recovery and see clear drivers for economically sensitive user-pays assets. In addition, increased mobility and policy support for renewables will be key catalysts for US utilities.”
Hurst says investors should consider infrastructure assets in two broad categories: user-pays assets and regulated assets. When it comes to user-pays assets, such as toll roads, rail networks and airports, revenue is dependent on how many people use the asset. As such, as economic growth recovers, so do the cashflows of the underlying infrastructure assets.
“With regulated assets, such as water, electricity and gas, returns allowed by regulators will typically increase if interest rates rise.”
Hurst says: “Given the large amount of stimulus proposed by US President Biden, and more expected in the US, and globally, we think there will likely be some cyclical inflation. But in the long term our view is that inflation will remain around 2%.
“Either way, rising inflation does not significantly affect utilities and infrastructure assets. Inflation generally gets passed through in the case of utilities via their cost of capital, while user-pays infrastructure assets with concessions and contracts will pass through inflation via tariffs and tolls.
“We have found there is little correlation between listed infrastructure and utility performance and inflation. Looking at the past 30 years, those periods of strongly rising bond yields have been one of the best periods for active managers to position their portfolios to take advantage of market dislocations. This has led to strong returns for investors of infrastructure assets in subsequent periods following the rate rise,” says Hurst.
