25 February 2016
A lack of public investment in infrastructure has been a feature in both developed and emerging economies over the past 30 years. But a combination of an historical underspend, an emerging middle class that will continue to demand more and better infrastructure, and governments with fragile fiscal positions has set the scene for significant private investment in infrastructure in the future.
Under investment by the public sector
Infrastructure Australia (IA) have indicated that without a total increase in both public and private funding of infrastructure, and market reforms to strengthen the transport and water sectors, Australia won't have the infrastructure that a growing population and our globally-focussed economy deserve.
There are similar experiences overseas. As an example, the B20 (the business arm of the G20) recently found that worldwide infrastructure projects account for approximately US$9 trillion of spending annually. However, by 2030, it is estimated that around US$60-70 trillion additional infrastructure capacity will be needed globally. Under current conditions, only approximately US$45 trillion is likely to be realised, leaving a gap of around US$15-20 trillion.
The new middle class
A key driver of infrastructure spending is within emerging markets which are in the midst of one of the most powerful and enduring themes the global economy will experience over the next 50 years – the emergence of a substantial middle class.
For example in 2000, Asia (excluding Japan) accounted for just 10 percent of global middle class spending. By 2030, this could reach as high as 40 per cent and move beyond 60 per cent over the longer term.
Chart 1: Source - 2010 OECD Development Working Paper 285
Chart 1: Shares of Middle Class Consumption, 2000-2050
This growing middle class will inevitably demand more and better infrastructure to service and support their improving living standards.
Potential Government response is limited
Historically, infrastructure investment has been the domain of the public sector. However, in the current environment, the potential government response to the need for infrastructure investment is limited due to the fragile fiscal positions of many governments.
This is particularly evident in those countries that were hit hard by the global financial crisis (GFC). Even in countries who have managed to make a solid recovery – such as Spain and Portugal, which are again delivering GDP growth - there is a residual GFC ‘hangover’. While both Spain and Portugal have seen their budget deficits contract, their public debt as a proportion of GDP has continued to rise.
Chart 2: Source - Bloomberg
Chart 2: Spain vs Portugal economic profile
These two countries are not alone. Many others are also experiencing recovering GDP growth, persistent fiscal deficits, and high or expanding public debt/GDP ratios. Canada, for example, has a public debt/GDP of 95 percent, the United States 75 percent, France 96 percent, Japan 232 percent and Italy 132 percent.
The implications for potential infrastructure spend by governments is clear – fragile fiscal and balance sheet positions will constrain public sector infrastructure investment over the medium term.
Private sector funding is part of the solution
The combination of a critical underspend on infrastructure, an emerging middle class and governments with fragile fiscal positions set the scene for significant private investment in infrastructure.
At 4D Infrastructure, we believe the case for much-needed global infrastructure investment being increasingly funded via the public equity markets around the world is compelling, as the fundamental characteristics that infrastructure assets offer are ideal for public market participation. These include:
These characteristics deliver companies with clear growth profiles, predictable, resilient and transparent earnings, and attractive dividend yields.
Indeed, historically the performance of global listed infrastructure (GLI) has been strong even during the tough market periods – when the broader market was flat or down.
Chart 3: Performance of the S&P Global Infrastructure Index v MSCI World Index
(from January 2004, characterised by type of monthly market performance)
In addition, returns have been accompanied by lower volatility compared with the broader equity market, while the quality of earnings from GLI stocks generally leads to higher dividend yields.
Chart 4: Source – Bloomberg
Chart 4: S&P Global Infrastructure Index Dividend Yield v MSCI World average
Asset privatisations: part of the transition mechanism
An important part of the infrastructure regeneration process is the privatisation of public assets. It is one of the options that cash-strapped governments will turn to in order to raise revenue, and is part of the public/private ownership transition mechanism that will lead to growth in listed infrastructure over the coming decades.
The NSW electricity asset privatisation program is just one example. The NSW State Government plans to lease, for 99 years, 100 percent of Transgrid, and 50.4 per cent of Ausgrid and Endeavour, with the aim of raising $20 billion from the privatisations to spend on road, rail and other infrastructure projects.
While the major purchasers of these assets will likely be superannuation and unlisted infrastructure funds, some of the equity will find its way to the public market, either at the time of purchase or over the longer term.
So far, in NSW the lease of TransGrid has been announced with a value of $10.3 billion. The winning NSW Electricity Networks consortium included the ASX listed Spark Infrastructure (SKI) which will hold 15 percent of the equity (for an investment of $734 million), and is partially funding this holding via a $405 million equity entitlement offer to existing shareholders.
The NSW experience illustrates how privatisations can lead to an expanded role for private sector finance, including the listed equity markets, in the infrastructure funding mix. It also shows how governments, faced with fiscal pressures but recognising the need for infrastructure capex, are willing to adopt forward thinking policies as a means of delivering on those objectives.
The global listed infrastructure market will play an increasing role in meeting a worldwide need for increased infrastructure investment and renewal over the coming decades. GLI’s strong historic performance, its capacity to out-perform in tough markets, with lower volatility of returns and strong dividends, makes it an asset class worth considering by all investors.
* Greg Goodsell is global equity strategist at 4D Infrastructure, a Bennelong Funds Management boutique.
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