Infrastructure funds proved their worth during the global equity market sell-off in the December quarter last year, playing their role as high-yielding and defensive equity investments.
Since then they have performed strongly, as investors have responded to falling inflation and interest rates by moving into so-called “bond proxies”, including infrastructure stocks.
For Shane Hurst, a portfolio manager and senior investment analyst at RARE Infrastructure, these conditions have allowed him to take profits from some RARE positions that have hit their price targets and reinvest in better value opportunities, while still producing high levels of income.
For the 12 months to the end of July, the RARE Infrastructure Income Fund produced a return of 17 per cent. Over the same period its benchmark, OECD G7 Inflation plus 5.5 per cent a year, was up 7.3 per cent.
The return was made up of 11.5 per cent capital growth and 5.5 per cent income. The fund targets a net distribution yield of 5 per cent a year and has exceeded that comfortably since it was launched in 2008.
It also targets low volatility of returns. Its standard deviation since inception has been below 10 per cent.
In a recent report, Zenith Investment Partners says that while global listed infrastructure funds invest in listed assets, they offer investors drawdown protection. This is because of the characteristics of the companies they invest in, which include stable income, high barriers to entry and monopoly market positions.
The global equity benchmark, the MSCI World ex-Australia AUD Hedged Index, fell 13.6 per cent in the December quarter, while the infrastructure benchmark, the FTSE Global Core Infrastructure 50/50 Index, fell just 2.1 per cent.
Hurst says the RARE Infrastructure Income Fund’s downside exposure since inception has been just one-third of the global equity market, while its upside capture has been two-thirds.
He says the protection comes because these companies are not subject to business cycles.
“When the MSCI World Index fell in the December quarter, our strategy was up a little. You tend to see that relationship through time.
“Our expectation is that inflation and interest rates will be lower for longer. In that type of environment global infrastructure will do well. Our names are essential services, such as poles and wires.”
The fund has relatively low portfolio turnover of around 35 per cent a year, although there has been an increase this year. The fund has been doing some recycling – selling stocks that hit their targets and buying better value elsewhere.
Hurst says: “Parts of the US utility market are expensive. We have sold some stocks to benefit from the cycle. We have got into Spain, where some of the electricity assets are below book value.”
One of those stocks is Red Electrica, which is in the Spanish transmission business. It was sold off on some negative concerns but then started to come back.
Two Canadian stocks in the portfolio are a Nova Scotia energy company Emera Inc and Hydro One.
Hurst says Hydro One became a valuation opportunity when it was sold off on political concern. It is the biggest rate-regulated electricity transmission and distribution company in Ontario.
In the case of Emera, the market believed it would issue equity to fund its growth and that would be dilutive. But the company sold some of its assets at a premium, significantly reducing risks associated with its funding plan for its capital expenditure program.
“We have been reducing our exposures in Australia, taking some profits from Transurban. It is still a very high-quality company with good cashflow and excellent assets, but its value was high,” he says.