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The pros of infrastructure investment in a lower-for-longer environment

Date: Oct 16th, 2019

Bridging troubled waters: the pros of investing in infrastructure

Global markets are yet to enter any serious downturns. Still, fragile growth outlooks, high levels of market volatility, record-low interest rates and myriad geopolitical and macroeconomic risks – not least of which is a trade war between the world’s two largest economies – will leave many wondering how they will meet their investment goals in the short to medium term.

The current investment environment is no doubt an uneasy one for many investors. Rather than wait for economic winds to change, investors could instead look to investment classes with outlooks that are less dependent on external and cyclical factors as some others. In this regard, infrastructure investment offers some compelling features in an uncertain climate.

 

What are some of the benefits of investing in infrastructure?

1.  Consistent returns with lower volatility1  through market cycles

Infrastructure assets are commonly “essential services” assets. This means people have to use them on a day-in and day-out basis. As a result, both utilisation and returns can often be less dependent on the prevailing economic climate than other investments. It is very hard for someone to get through a day without having to use some form (or forms) of essential infrastructure such as electricity, water, gas, schools, hospitals, roads, rail and airports.

In addition, infrastructure assets often benefit from significant barriers to entry in the markets in which they operate. They can have contractual protection from competition by government, while high costs and long lead times for construction provide natural monopolies, and give advance warning and further insurance against new competitive threats to existing revenue streams.

For this reason, returns are often more reliable than those associated with comparable assets outside the sector. Figure 1, below, compares the performance and volatility of infrastructure in various forms, with a range of other asset classes being Australian equities, global equities, global bonds, and global real estate investment trusts (Global REITs). It demonstrates that that over the last 10 years, on an annualised basis, and relative to other asset classes with comparable performance, returns on infrastructure have been delivered with much lower levels of volatility.

Figure 1: Return and volatility of selected asset classes, 10 years to 30 June 2019.3

 
Past performance is not a reliable indicator of future performance.

2. Reliable long-term income yields

Infrastructure asset revenues are often underpinned by regulation or long-term contracts, which provide a high level of visibility of, and certainty around, future cashflows from the asset.

The most obvious example of this in practice occurs with Public Private Partnerships or ‘PPPs’ which are often used by governments to deliver infrastructure projects such as roads, hospitals, schools and public transport systems.

Concessions for assets such as these are often granted over lengthy contractual periods (which can be 30 years or more) and typically offer ‘availability’ revenues, which are paid on the basis that the asset is made available and maintained in a fit state for the intended use, irrespective of the extent to which it is actually used.

For example, in the case of a school of this type, so long as the asset is maintained in a fit state and made available for use, the asset owner gets paid a fixed amount irrespective of the number of students that are enrolled in the school.

Isolation from usage risk in this manner provides a unique level of visibility and security of future revenues from the asset, particularly given that the counterparty responsible for making the availability payments is often a highly creditworthy government body. In addition, infrastructure asset revenues are often linked to inflation, which can help investors protect against the erosion of the value of their investment by inflation over time.

3. Diversification and reduced overall portfolio risk

Overall portfolio diversification is improved when assets have a low level of correlation2 – that is, where assets don’t behave the same way at the same time. The infrastructure asset class, and unlisted infrastructure in particular, has historically demonstrated low levels of correlation with other asset classes, meaning its inclusion in a broader portfolio can be an effective means of reducing overall portfolio risk.

This is illustrated in Figure 2, below, which compares the correlation of various forms of infrastructure investment with a range of other asset classes being Australian equities, global equities, global bonds, and global real estate investment trusts (REITs).

As can be seen, most listed indices are highly correlated with one another, suggesting that even portfolios that were spread across a number of listed asset classes would be poorly diversified. Bonds are negatively correlated with other asset classes, and represent an effective option for diversification, albeit one which traditionally has offered lower long-term returns (see Figure 1.)

Infrastructure, and particularly unlisted infrastructure, displays low correlation with many other asset classes, making it another option for investors wishing to diversify their portfolio, and an attractive one given the historically strong returns illustrated in Figure 1.

Figure 2: Quarterly return correlations for selected asset classes, 10 years to 30 June 2019.3


Past performance is not a reliable indicator of future performance.

Conclusion

Many investors have cottoned on to the benefits of infrastructure, and we expect this to heighten. There is a significant need for new infrastructure in both developed and developing economies. With governments across the globe burdened with high levels of debt, fewer infrastructure projects are likely to be publicly funded. The need for private capital to replace ageing infrastructure or fund new projects will consequently persist over the long term, which we believe will support a broad and growing range of infrastructure investment opportunities.

 

Author: John Julian, Investment Director – Infrastructure Equity, Sydney, Australia

Source: AMP Capital 10 Oct 2019

Volatility is a means of measuring investment risk. It is a probability measure of the standard deviation of expected returns, and hence can provide a useful comparative measure of the relative risk of different investments over a particular time period.

2 Correlation is another comparative statistical measure. It shows how asset valuations move relative to each other. For example, if assets have a correlation of 1, their values move exactly together. Hence, the addition of assets with a correlation of 1 to a portfolio would provide no diversification benefit. If the correlation was -1, the valuations would move exactly opposite to each other, providing great diversification benefits by lowering the volatility of the portfolio. Interestingly, Figure 1 shows that the volatility of a portfolio of 50% listed and 50% unlisted infrastructure is much lower (~5.5%) than would be expected by simply averaging the volatility of each (~7%). This is because of the low correlation of unlisted infrastructure to listed infrastructure as can be seen in Figure 2 (0.13).

3 Notes to charts:
The charts compare the returns, volatility and correlation of a range of asset classes represented by the indices specified below. Different asset classes will offer different investment features, including differing levels of liquidity.

Unlisted Infrastructure represented by the MSCI Australian Unlisted Infrastructure Index. Listed Infrastructure represented by the Dow Jones Brookfield Global Infrastructure Net Accumulation Index. Global Treasury Bonds represented by Bloomberg Barclays Global Treasury GDP Index. Global Equities represented by the MSCI World Net Accumulation Index. Global REITS represented by the FTSE EPRA NAREIT Developed Rental Net. Australian Equities represented by the S&P/ASX 200 (franking credit adjusted). 50/50 Unlisted/Listed Infrastructure Portfolio represented by a 50% weighting to the MSCI Australian Unlisted Infrastructure Index, and a 50% weighting to the Dow Jones Brookfield Global Infrastructure Net Accumulation Index. All data in AUD. All data is for the period 31 March 2009 to 30 June 2019, except for the FTSE EPRA NAREIT Developed Rental Net index where data is for the period 31 May 2009 to 30 June 2019 (as the data series only began in May 2009).  

Important notes: 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) (AMP Capital) 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 and must not be provided to any other person or entity without the express written consent of AMP Capital.

Monetary Policy Decision – Statement by Philip Lowe, RBA Governor, October 2019

Date: Oct 04th, 2019

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 0.75 per cent.

 

While the outlook for the global economy remains reasonable, the risks are tilted to the downside. The US–China trade and technology disputes are affecting international trade flows and investment as businesses scale back spending plans because of the increased uncertainty. At the same time, in most advanced economies, unemployment rates are low and wages growth has picked up, although inflation remains low. In China, the authorities have taken further steps to support the economy, while continuing to address risks in the financial system.

Interest rates are very low around the world and further monetary easing is widely expected, as central banks respond to the persistent downside risks to the global economy and subdued inflation. Long-term government bond yields are around record lows in many countries, including Australia. Borrowing rates for both businesses and households are also at historically low levels. The Australian dollar is at its lowest level of recent times.

The Australian economy expanded by 1.4 per cent over the year to the June quarter, which was a weaker-than-expected outcome. A gentle turning point, however, appears to have been reached with economic growth a little higher over the first half of this year than over the second half of 2018. The low level of interest rates, recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some established housing markets and a brighter outlook for the resources sector should all support growth. The main domestic uncertainty continues to be the outlook for consumption, with the sustained period of only modest increases in household disposable income continuing to weigh on consumer spending.

Employment has continued to grow strongly and labour force participation is at a record high. The unemployment rate has, however, remained steady at around 5¼ per cent over recent months. Forward-looking indicators of labour demand indicate that employment growth is likely to slow from its recent fast rate. Wages growth remains subdued and there is little upward pressure at present, with increased labour demand being met by more supply. Caps on wages growth are also affecting public-sector pay outcomes across the country. A further gradual lift in wages growth would be a welcome development. Taken together, recent outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.

Inflation pressures remain subdued and this is likely to be the case for some time yet. In both headline and underlying terms, inflation is expected to be a little under 2 per cent over 2020 and a little above 2 per cent over 2021.

There are further signs of a turnaround in established housing markets, especially in Sydney and Melbourne. In contrast, new dwelling activity has weakened and growth in housing credit remains low. Demand for credit by investors is subdued and credit conditions, especially for small and medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality.

The Board took the decision to lower interest rates further today to support employment and income growth and to provide greater confidence that inflation will be consistent with the medium-term target. The economy still has spare capacity and lower interest rates will help make inroads into that. The Board also took account of the forces leading to the trend to lower interest rates globally and the effects this trend is having on the Australian economy and inflation outcomes.

It is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target. The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.

 

Source: Reserve Bank of Australia, October 1st, 2019

Enquiries

Media and Communications
Secretary’s Department
Reserve Bank of Australia
SYDNEY

Phone: +61 2 9551 9720
Fax: +61 2 9551 8033

Email: rbainfo@rba.gov.au

The way forward for commercial real estate investment in a challenging market

Date: Sep 17th, 2019

The return environment in commercial real estate has become more challenged, with pockets of outperformance matched by underperformance, not only across the sectors but, more frequently, within the same sector.

Against this backdrop, passive portfolio management pegged to a benchmark has begun to look outdated.

By shifting our focus to one of active management with the freedom of a benchmark-unaware approach we now have more levers to pull in terms of portfolio construction and risk management.

This means we can take a more holistic approach to the construction and management of the portfolio, better capitalising on opportunities in the real estate market and managing the downside risks.

Sector selective

A great illustration of how we can better manage risk for our investors is how our active approach has allowed us to de-weight the portfolio’s exposure to the retail sector.

Over the course of the last 18-24 months our research had helped us identify that investments in the retail sector would be challenged from a returns perspective for the next few years due to the continued rise of online shopping and cyclical headwinds such as low wages growth and a more moderate housing market.

However, the Australian Real Estate Investment Trust (AREIT) index – in which we were previously invested – has a ‘look-through’ exposure to the retail sector of about 50 per cent.

By adopting an approach that means we are no longer constrained by this passively-managed AREIT exposure, we have instead been able to build a bespoke portfolio of retail assets, being selective about the type of assets that we are comfortable holding.

These include assets such as dominant regional shopping centres, as well as neighbourhood and convenience-based centres, which have a point of difference that means customers will continue to shop there, resulting in the asset continuing to be able to attract tenants throughout the market cycle.

Backing the winners

Conversely, active management has also allowed us to double down in areas that we see providing runways to growth.

Industrial real estate, and, in particular, logistics-related assets, has been a real outperformer as it is positioned as a beneficiary of the growth in e-commerce, and as a result of our active management approach we have been able to increase our exposure to this sector.

Similarly, in the office market, we are currently focused on the Sydney and Melbourne CBDs where there has been a significant withdrawal of stock over the last few years. As a result, there’s been limited new supply in the market and that has resulted in record low vacancy rates in both of those markets.

Another structural trend that we are looking to take advantage of is the global aging population. This translates into growth in healthcare real estate facilities and low-cost retirement housing assets, such as manufactured housing. We have been able to increase our weighting to these exposures, resulting in a well-diversified portfolio.

Conclusion

By having the flexibility to target growth sectors while being selective in our exposure to under performers, we feel confident we can deliver better diversification and risk-adjusted returns for our investors.

https://vimeo.com/355947376

 

Author: Claire Talbot, Fund Manager – Real Estate Sydney, Australia

Source: AMP Capital 11 Sept 2019

Important notes: While every care has been taken in the preparation of this information contained in this website, neither AMP Capital Investors Limited (ABN 59 001 777 591)(AFSL 232497) nor any member of the AMP Group make any representation or warranty as to the accuracy or completeness of any statement in it including without limitation, any forecasts. This content has been prepared for the purpose of providing general information only, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of the information on this website, and seek professional advice, having regard to their objectives, financial situation and needs. Content sourced from Cuffelinks and Livewire does not represent the views of AMP Capital or any member of the AMP Group. All information on this website is subject to change without notice.

The Importance of Being Nearest: how inner-city industrial space is transforming

Date: Sep 17th, 2019

If you’re a celebrity in New York, an apartment in a Tribeca warehouse conversion is a prized accessory. Taylor Swift has a place there, as does Beyoncé. One apartment block on Greenwich Street recently boasted a roll-up of owners that included Justin Timberlake, Jennifer Lawrence, Harry Styles and Jake Gyllenhaal. Despite their exclusivity today, some of the most prized aspects of these conversions betray their more utilitarian origins – their high ceilings and large windows allowing for natural light and airflow through the crowded workspaces of yesteryear.

From the Embarcadero in San Francisco to Shoreditch in London, and closer to home in suburbs like Docklands in Melbourne, inner-city industrial suburbs across the globe have been transformed into sought-after residential postcodes. Emblematic of this trend was the announcement this year that the City of Sydney will rezone entire blocks of warehouse space in Alexandria to create a new cultural and entertainment precinct.

As residents and developers moved in, traditional industrial tenants have fled to the suburbs, into larger premises with cheaper rent. For retail logistics in particular, this made sense: the stores they were supplying were larger and increasingly located further away from traditional urban centres.

In an interesting reversal, however, the paradigms that forced industrial space out of our city centres and into the suburbs no longer hold true for retail logistics. As sales move online, and the time taken to span the “last mile” from warehouse to consumer becomes the critical metric for retailers, proximity is fast becoming king, and thanks to decades of competition from booming residential markets, space is at a premium.

This isn’t just about the more traditional, package-based model of online retail – It is true even for bulk retailers such as grocery stores – much of the demand for inner-city warehouse space is being driven in Australia by Australia’s largest super-market chains, responding to consumer demands which today require deliveries to be with the customer almost immediately. The trend may well be amplified by the increasingly refined power of retailers to predict purchasing behaviour, and transport and store products in proximity to their customers in anticipation of the purchasing decision, ensuring the right inventory product mix is being warehoused at the right location.

The result, in most major cities, would be a significant shortage of well-located, strategic industrial product. Returns for those who have held on to inner-city industrial space, or taken the time to invest strategically in infill urban logistics, are, in our opinion, likely to be sustained and substantial, further leveraged by trends towards inner-urban living, increasing pace of lifestyles and advances in technology.

Property values in these areas will likely be more resistant to any down-turn in the market than more remote sites, as investors continue to realise the benefit of strong cash flows from retailers who are prepared to pay a premium to get their products into the hands of consumers on shorter turn-arounds than their competitors.

There will be few better examples of these dynamics in action than in South Sydney, which is at the centre of a perfect e-commerce storm. Already located on the doorstep of Kingsford-Smith Airport, Australia’s busiest freight airport, and Port Botany, our second-largest container terminal, industrial property in places like Alexandria and Waterloo has long benefited from its location between these two hubs and the dense inner suburbs of Sydney. Today, this advantage has been super-charged by residential developments which have created Green Square, the densest urban area in Australia, right in the midst of these existing industrial holdings. Add in the completion of WestConnex, the Sydney Gateway project and the Port Botany Rail Duplication, and it’s not hard to comprehend that demand for logistics space in this neighbourhood is only likely to increase into the foreseeable future.

 

Author: James Maydew, BSc (Hons), MRICS Head of Global Listed Real Estate, Sydney, Australia

Source: AMP Capital 29 August 2019

Important notes: 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) (AMP Capital) 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 and must not be provided to any other person or entity without the express written consent of AMP Capital.

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