[00:00:49] Rising interest rates on the infrastructure sector - where are we now in the rate cycle and how is this impacting valuation?
When interest rates rise in response to elevated inflation, infrastructure assets, which inherently provide inflation protection, tend to be resilient as the impact on their earnings is offset by the link to inflation. However, impact arises when interest rates increase more than inflation, particularly if there is a rise in real interest rates (adjusted for inflation). In the first nine months of 2023, there was an increase in both nominal and real interest rates, causing the investment performance of long-duration assets like infrastructure to struggle. Yet, in the last quarter, a decline in real interest rates resulted in a strong performance for infrastructure.
[00:03:11] Is a CPI+5% return goal for infrastructure investments still appropriate?
When considering returns on investments, particularly in infrastructure, it's crucial to distinguish between short-term and long-term perspectives. When we are talking CPI+ 5% for infrastructure investments, we’re talking about long-term returns. Our case for infrastructure, is that we believe you can grow your wealth over time with a high degree of confidence with an expectation of about CPI+5%.
Key Takeaways
[00:05:22] Investment decisions within the infrastructure strategy
One significant change over the past year has been the inclusion of Brookfield Renewables in our investment universe. Traditionally, our concerns with renewables centered around the relatively short average take-or-pay agreements, exposing investors to potential power price risks upon contract repricing. However, Brookfield Renewables, specialising in wind and solar power, stood out due to its longer average contract duration of approximately 15 years. This extended contract durations in Brookfield Renewables meet our infrastructure criteria. We view it as part of the energy infrastructure space, distinct from a utility, where pricing is regulated through contracts, providing an opportunity for growing returns over time.
[00:08:06] The portfolio positioning for 2024
Our current portfolio is comprised of approximately 55% infrastructure and around 45% regulated utilities, with a slight overweight to infrastructure over utilities compared to our long-term expectation of a 50/50 split. The three major sector weights in our portfolio are electric utilities, making up over 30%, toll roads at slightly over 25%, and airports at about 10%. We see electric utilities benefiting significantly from the global transition to net zero, with opportunities arising from increased demand for renewable energy. Toll roads exhibit resilience, with traffic levels bouncing back even after the pandemic-related disruptions. Airports, comprising roughly 10% of our portfolio, have experienced a strong recovery, particularly in North America and Europe, with Asia-Pacific expected to catch up as economies reopen.
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