Justin Lannen

With significant potential for geopolitical and economic uncertainty in 2025, defensive essential service assets such as infrastructure are well positioned, according to Justin Lannen, portfolio manager in the global listed infrastructure team at Maple-Brown Abbott.

“Despite the geopolitical turmoil, we remain optimistic about 2025 and believe that the outlook for defensive, essential service assets such as infrastructure remains strong, especially when compared to more economically sensitive asset classes should economic demand weaken.

“The actions of central banks in 2024 was largely driven by the evolving economic outlook across different regions, and in response a rate cutting cycle started. However, we are hesitant about whether central banks will make further material reductions in 2025 due to ongoing economic strength.

“Our long-term assumptions with interest rates remain approximately in line with current market rates. If central banks do make further reductions, any decline in real long-term interest rates would provide relief for the infrastructure sector.

“Lower rates could further support the sector, enhancing its appeal as an investment and contributing to the stability of infrastructure-related assets,” says Mr Lannen.

Inflation looks to be on the decline globally, however Mr Lannen doesn’t expect it to return to pre-COVID levels in 2025 and continues to see value in the embedded inflation pass- through mechanisms within infrastructure regulations and contracts.

“These features provide a degree of protection against inflationary pressures, ensuring that infrastructure remains an attractive asset class in a potentially volatile macroeconomic environment.”

Mr Lannen says the fund continues to favour monopolistic infrastructure assets that are trading at attractive discounts to internal valuations, protected by regulation and strong contracts with inflation linkage and growth being driven by capital expenditure requirements.

“We see substantial organic growth opportunities for global listed infrastructure, predominantly driven by the energy transition but also supported by themes such as water, transport mobility and digitalisation.

“Cell towers remain a large allocation in our fund. We think cell towers are a strategic and forward-looking investment opportunity for 2025. The convergence of technological advancements, surging data consumption, and the sector’s inherently defensive earnings profile, create a strong foundation for future growth. As connectivity becomes ever more integral to modern life, cell towers are well-positioned to capitalise on the expanding demand for communications infrastructure.

“Water utilities are another sector that we are favourable about especially assets in the UK. The close of 2024 brought a significant event for the UK water sector with OFWAT’s regulatory price review and final determination for the 2025-30 period. This regulatory decision marks a significant milestone, offering much-needed clarity for the industry.

“There will be a large increase in capital expenditure over the coming five years to improve the operating and environmental performance of most UK water companies. Allowed sector expenditure (opex and capex) is increasing from £61bn to £104bn over the five-year period to 2030.

“Companies like Severn Trent and United Utilities are well positioned for the upcoming regulatory period,” he says.

Large amounts of capital continue to be invested by infrastructure companies to facilitate mega themes including decarbonisation, digitalisation, water quality and transportation, says Mr Lannen.

“Substantial long-term capital is needed to support investments in the world’s infrastructure networks and to support these mega themes.

“The geopolitical and macroeconomic landscape for 2025 presents much to consider, and stability is unlikely. However, we believe global listed infrastructure is an asset class that investors can find inflation-linked cash flows and attractive rates of return.”

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Justin Lannen

Global listed infrastructure performed true to label in 2022, which was a tumultuous year for asset markets. The sector lagged global equities over 2020 and 2021, missing out on a lot of the froth that formed in some asset markets.

For the year ending 31 December 2022, listed infrastructure outperformed global equities, with the FTSE Global Core Infrastructure 50/50 Index (AUD) returning 2.0%^[1]. Global equities as measured by the MSCI World returned -12.6% in AUD terms.

The inflation protection that tends to be embedded in many infrastructure assets helped soften the increase in interest rates, and we believe the generally defensive exposure driven by the essential service nature of infrastructure helped returns.

But what about 2023? Asset markets remain volatile, but there are signs already of what might be coming.

There are early signs that inflation recently peaked and real interest rates have come off their recent highs. This means the market believes central bank actions will ultimately be successful, even if inflation looks like it will remain stubbornly high compared to the past decade.

In our view, the inflation protection in many infrastructure assets, such as toll roads that can pass inflation on via toll rates to motorists or regulated utility networks that have their asset base increased by inflation each year, should be protected from further increases in inflation.

Ultimately, we think the best returns on a risk-adjusted basis are generated in the listed infrastructure assets class through stock picking with a focus on valuation, inflation protection, low cashflow volatility and strong environmental, social and governance (ESG) credentials.

Overlaying this, there is a shortage of infrastructure globally that is needed to improve living standards and the environment. Large amounts of capital need to be invested over coming decades by both private infrastructure owners and government.

We believe the key opportunities are in listed infrastructure companies that play a role in themes such as the energy transition, electrification of society, transport mobility and digitalisation. We are seeing opportunities in renewable energy developers such as UK listed SSE plc, which owns regulated electric networks in Scotland along with the largest offshore wind asset portfolio in the UK. A very large opportunity exists in the ‘great re-wiring’ of the electric grid to support the energy transition to renewables. Toll roads and telecommunication tower networks presently offer good valuation opportunities in our view for assets that are necessary for the proper functioning of a modern society and also have resilience in earnings should the world face recessionary conditions in 2023, which is a view held by many market economists.

Opportunities in toll roads and telecommunication assets

Both toll roads and telecommunication assets are trading at significant discounts to our valuations after some weakness over 2022. Interestingly, we have not seen a corresponding softening of values for these assets in the direct infrastructure market, reflecting a divergence between the markets. This divergence has driven a couple of takeovers in our portfolio holdings in these sectors over 2022, so that might be a repeating theme should the gap between listed and direct infrastructure be maintained.

When we look at risks, the main one for the listed infrastructure sector is rising real interest rates, which impacts the discount rate of all risk assets, but perhaps more so infrastructure due to the long duration cashflow profile. US 10-year real rates have moved up from an unsustainably low level of around -1.0% at the start of 2022 to around 1.6% as at 31 December 2022. Global economic weakness in 2023 should keep a lid on this risk over the next 12 months, but we remain watchful and aware of each individual company’s sensitivity to this risk.

Continuing global energy crisis

It looks like the global energy crisis is here to stay with the Russian war in Ukraine looking protracted. We avoid investing in companies with material direct exposure to commodity prices, however we see benefits for renewable energy developers in Europe and the UK who are accelerating their roll-out of new renewable generation under long-term contracts.

Governments and regulators are supportive of reducing reliance on Russian gas. Meanwhile in the USA, the Inflation Reduction Act (IRA) signed into law by US President Joe Biden in August 2022 provides certainty for tax credits available to renewable developers and other asset builders who are enabling the decarbonisation of the USA. The IRA will underpin years of investment necessary to decarbonise the US energy system. Also in the US, the tight global liquified natural gas (LNG) markets are proving lucrative to LNG export infrastructure.

Mitigating political intervention risk

In the infrastructure sector, there is the ever-present risk of political intervention, and this is heightened by various bill pressures that we are seeing globally due to higher energy prices and inflation. We keep a close eye on this risk, and it is the reason we prefer regulatory regimes that have a reliable track record and are operationally independent from government like the situation in the UK and the UK’s water regulator OFWAT.

By Justin Lannen, co-founder and portfolio manager, Maple-Brown Abbott Global Listed Infrastructure

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[1] Past performance is not a reliable indicator of future performance

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