Infrastructure investments don’t always offer the diversification benefits investors expect, especially when they’re publicly traded.
“For listed infrastructure to have a chance at fulfilling the goal of providing a unique experience within a broader portfolio, a tight definition of infrastructure is needed,” says David Wong, managing director of investment management research at CIBC Asset Management Inc.
Investors usually turn to infrastructure to provide stable yield, non-correlated returns and defensive portfolio characteristics. But research has shown those benefits are easier to find in the private market. Wong suggests finding managers that focus on pure-play infrastructure.
Read: The case for investing in global infrastructure
“Companies that typically own or operate infrastructure assets that have desirable high barriers to entry and relatively inelastic demand are the ones that have the ingredients to provide that differentiated outcome,” he says. “Stretching the definition to include infrastructure-related businesses, such as construction and engineering companies, which have a higher degree of uncertainty, can introduce broader equity-market characteristics into the mix.”
Wong says the key characteristics of pure-play infrastructure are:
- Contractual, steady cash flows;
- Inflation protection (ideally via an indexed contract); and
- Monopoly power.
He looks for managers that score companies across these characteristics. “Thinking about the cash-flow volatility and scoring that through a cycle is one way to make sure you’re taking some cyclicality out,” says Wong.
One example of a pure play is toll roads, “which can have demonstrated lower volatility, even in economic downturns,” says Wong. City roads tend to have reliable traffic, regardless of economic conditions.
Read: CPPIB and Teachers’ invest in Mexican toll road
Some assets with similar physical properties to infrastructure may not actually be pure plays. Wong points to U.S. railways, saying, “Even though the physical assets are structurally advantaged, there is competition.” The Association of American Railroads boasts 20 full members, for example.
Further, rail contracts tend to be shorter than with other infrastructure assets, “and the tie-in with the economic cycle is a little bit greater,” says Wong. As such, a railway investment “isn’t necessarily outside of the bounds of the physical properties of infrastructure but it will provide a certain increased level of risk relative to the most pure-play definition.”
This article originally appeared on the website of Benefits Canada’s companion publication, Advisor.ca. It’s the second of a two-part series on infrastructure. Read part one for more on when infrastructure doesn’t diversify.