25 June 2020
Over the past decade, investment allocations to private infrastructure have more than quadrupled from $129 billion to $582 billion . This increased flow of funds into the asset class is expected to continue, driven by the continued inflow of capital into superannuation funds, pension funds, insurance companies and sovereign wealth funds; and their appetite for low volatility cashflow generating investments. Indeed, the allocation of funds to direct infrastructure is expected to exceed $1 trillion by 2023 .
An alternative to direct infrastructure investment is investing in infrastructure companies listed on global equity markets, either directly or through dedicated listed infrastructure managers. Listed infrastructure started to be recognised as its own asset class around 2005, with dedicated listed infrastructure funds like the 4D Global Infrastructure Fund becoming available to investors.
In this article, Senior Investment Analyst Peter Aquilina  and Global Portfolio Manager Sarah Shaw discuss why 4D Infrastructure believes direct and listed allocations complement each other in portfolio construction. They invest in the same type of assets – if not the exact same asset – while providing investors different ways to access the asset class depending on the investor’s appetite for asset concentration versus diversity, liquidity versus volatility, fees, execution risk, etc. With listed infrastructure allocations lagging direct infrastructure allocations, and with listed equity market valuations depressed, we believe a real opportunity has emerged in the listed infrastructure market.
Direct/unlisted infrastructure involves taking a direct stake(s) in infrastructure companies/assets (used interchangeably below for direct investment) which are not typically traded on public equity markets. The investor is often looking for control or management influence. These assets are revalued periodically at the discretion of the investor, or in line with accounting and regulatory standards. Direct infrastructure investors occasionally acquire holdings in companies that have securities traded on public markets. Usually this involves acquiring large stakes, often with positive or negative control provisions (e.g. the listed Vienna Airport is partly owned by IFM, a major player in the direct space).
Listed infrastructure involves investing in infrastructure companies which are traded on public equity markets. Relatively smaller shareholdings are taken in publicly traded shares, generally with no management control associated. As these companies are publicly traded, they are repriced daily by equity markets and can be bought and sold in a timely manner (providing liquidity).
Direct and listed infrastructure investors invest in fundamentally the same type of, if not the exact same, underlying assets. Their definition of infrastructure is the same or very similar, and they are both looking for real assets with infrastructure characteristics that underpin long-term visible and resilient earnings. At 4D, we believe direct and listed infrastructure exposure simply offers investors different means of accessing the same asset class.
Figure 1: Listed vs unlisted similarities
Even though the underlying companies/assets of both direct and listed infrastructure investments are fundamentally the same, how investors access the asset class can differ significantly between the two investment styles. These key differences are summarised below:
Figure 2: Listed vs unlisted differences
The performance correlations between direct and listed investments over an investment cycle has historically been high. Using available market indices as valuation proxies for listed and direct infrastructure markets, the correlation between the investment styles can be observed in Figure 3, with the direct infrastructure index (Wilde/Preqin – red line) highly correlated with the listed infrastructure index (GLIO – black line) over the long term. Figure 3 also shows that even though listed and unlisted market performances are closely aligned over time, short-term mispricing in listed infrastructure markets provides opportunities for active managers like 4D to deliver alpha.
Figure 3: Listed vs unlisted asset performance over time
Source: Reuters, GLIO & Wilde/Preqin
Anecdotally it feels that the intense competition for private infrastructure acquisitions over the past 10-15 years has resulted in execution valuation metrics in excess of that of trading peers. We have looked to test if there is any validity to this by analysing EV/EBITDA transaction multiples against the average of trading peers across infrastructure sub sectors. In Figure 4 we have plotted the average implied EV/EBITDA multiples by sector over the past five years for listed infrastructure by sector, against the same implied multiple for select direct investment transactions across sectors over the same timeframe. Our key takeaway from this analysis is that there appears to have been a clear valuation dislocation between listed trading multiples and direct infrastructure transactions, across all infrastructure sectors over the analysed period.
Figure 4: Listed vs unlisted valuation multiples: 2015 - 2020
Source: Infrastructure Journal Online and 4D Infrastructure
We then looked to analyse the relative valuations between listed infrastructure stocks and market transactions within specific sectors. We compared the average trading range within the airport (user pay) and water (utility) sectors over the past 10 years with direct investment transaction multiples within those sectors. Figure 5 confirms our view that the vast majority of private transactions occur at multiples towards the top end or above the range of listed valuation multiples.
Figure 5: Airport and water transaction multiples: 2010-2020
Source: Infrastructure Journal Online and 4D Infrastructure
Based on our conclusion that direct infrastructure investments have been transacting at significant premiums to their listed counterparts, the key question is: why does this dislocation exist?
The COVID-19 pandemic pushed the international economy into recession and cut a swathe through global equity markets. From 21 February through to the end of March 2020, the US S&P 500 equity index was down 23.2% and the MSCI World index was down 23.1%.
Listed infrastructure was certainly not immune to this value erosion, with the recognised infrastructure indices down 18-32% over the same period. This price volatility could continue for a while yet, until it becomes clearer that health authorities around the world are getting on top of the outbreak. However, it is important to remember that infrastructure is a very long duration asset with a 5-10+ year investment horizon. Once we move past the worst impacts of the virus and the world’s economy returns to a more stable environment, all forms of infrastructure will be integral to the economic recovery and returning society to ‘situation normal’. There is no global growth recovery without roads, railways, pipelines, power transmission networks, communication infrastructure, ports and airports .
Unlisted infrastructure players have also recently assessed the impact of COVID-19 and adjusted their asset valuations down, but by a much smaller percentage than the listed market falls. For example, the media has reported:
We believe the real fundamental valuation impact of the COVID-19 pandemic on these assets is more closely aligned with the unlisted valuation shift. There is clearly a significant near-term earnings impact for some of the infrastructure sectors, namely airports, toll roads and other User Pay sectors that justifies a cut to valuations. However, the longer-term fundamentals of the stocks/sector suggest the listed market has completely oversold these assets on what we consider to be an event-driven earnings shock. We believe this will prove to be a buying opportunity for these assets if investors can look through the near-term earnings hit.
Using an airport as an example, short-term investors valuing an airport on a one-year price-to-earnings (PE) multiple will be slashing their target prices as the one-year earnings outlook is dramatically cut as a result of the COVID-19 driven grounding of flights. However, infrastructure is a very long duration asset class, which should be valued with a recognition of its implicit longer-term cashflow generation. As discussed, 4D values these assets using a long-term DCF methodology to determine intrinsic fair value. While a one-year earnings (cash flow) hit will impact this valuation, with asset lives of 50+ years a one-year hit does not justify the significant drop in value that equity markets have attributed. We believe that while COVID-19 is causing significant disruption and earnings impacts globally, it will resolve and life will return to a new normal. We also believe the long-term structural opportunity for airports remains intact and very strong – traffic will recover and with it, earnings and cashflow.
We believe this widening value disconnect between listed and unlisted valuations represents a significant opportunity for listed infrastructure investors.
Infrastructure as an asset class is increasingly on the radar of investors and their advisers. Its defensive attributes, coupled with a significant global growth opportunity as a result of decades of underspend and the changing dynamics of the global population, create an attractive long-term thematic for the sector which is intact despite the near-term concerns of COVID-19. Despite the huge investment need, competition for operational assets remains strong and in the near term could prove to be a sector overhang, which is something we are monitoring closely.
As outlined at the start of this paper, the capital flow from institutional investors to direct infrastructure is expected to surpass $1 trillion by 2023. The 4D defined listed infrastructure universe by market capitalisation is also growing rapidly, from <$2trn in 2006 to ~$4trn at the end of 2019, as more and more specialised operators look to capitalise on the asset fundamentals and build for the future in supportive low interest rate environments like the present. Examples of infrastructure managers which have raised significant capital over the past 12 months include:
The amount of capital competing to be invested may come with an increase in investor risk, and potentially increasing activity within and between the direct and listed investment pools. This could result in sub-optimal outcomes for investors, namely:
1. Capital may get stuck in long commitment queues as managers can’t put it to work (estimated by the Global Listed Infrastructure Organisation (GLIO) at +$100 billion);
2. Management teams look to invest in opportunities outside their core business strategy. This is often to drive growth to achieve financial remuneration incentive targets, when core business growth drivers are more difficult to come by;
3. Management teams/managers starting to look further up the risk/return spectrum for acquisition targets due to high competition for core infrastructure investments:
a) “Core +” and “Core ++” assets can generate immediate cashflow but expose investors to greater and different risks than they would expect from traditional infrastructure (examples include bus networks; service stations; waste management (garbage trucks and dumps); data centres; land titles businesses; and student accommodation)
b) New builds which carry greenfield risk (construction and ramp up risk) with a lag to cash flows; and4. Acquirers increasingly look to equity markets for private transactions – even paying a significant premium to current listed equity valuations would see multiples below recent unlisted transactions:
We are very conscious of the increased competitive dynamic and see it as a core risk to the asset class, particularly given the ease of access to plentiful and cheap capital. As such we assess each stock in our universe on strategy and capital discipline to ensure our investors are gaining exposure to what we consider to be core infrastructure characteristics acquired at valuations that earn a viable return over the asset life.
Both direct and listed infrastructure investment styles offer benefits to investors in their defensive, predictable earnings through economic cycles, low volatility, stable cashflow generation, and long-term growth. They both invest in fundamentally the same assets (if not exactly the same assets). Direct infrastructure investment offers investors lower volatility and greater management control, which is very attractive to some institutional investors like superannuation/pension funds and sovereign wealth funds. However, this lower volatility and management influence comes with illiquidity, higher gearing levels, higher costs/fees and more concentration. By contrast, listed exposure provides investors liquidity, increased asset and geographic diversity, and lower fees – but with significantly higher in-cycle volatility.
The infrastructure asset class continues to experience large capital inflows from institutional and retail investors alike. This capital flow has increased competition for suitable investment targets in both direct and listed markets. Investors need to be wary of perverse outcomes as managers of capital struggle to find suitable investment opportunities that fit the investment criteria of infrastructure. These include capital being held up in long commitment queues; managers looking for investment/growth outside the core definition of infrastructure; and assets transitioning between listed and private markets to the detriment of one investor type.
We at 4D believe that both direct and listed infrastructure offer compelling investment attributes that make them both suitable as a long-term allocation for investors. We also believe that a balance between direct and listed exposure is optimal in portfolio construction. This provides investors with the same infrastructure exposure, but with a balanced mix of complementary style-specific qualities.
In the current environment, with listed infrastructure prices offering very attractive value as a result of the depressed equity market conditions, we believe timing supports allocations to listed infrastructure markets. In this market, specialised managers like 4D have the opportunity to generate alpha returns as a result of the market dislocation.
Download a copy of the article here.
Below is more detail on a selection of the direct infrastructure transactions identified in Figure 4.
Source: Infrastructure Journal Online and 4D Infrastructure
 Preqin 2020 Global Infrastructure Report – In Focus: How Big Will Infrastructure Get?
 Preqin 2020 Global Infrastructure Report – In Focus: How Big Will Infrastructure Get? Peter Aquilina spent 10 years on the direct infrastructure side before transitioning to listed infrastructure investing at 4D Infrastructure.
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