Macquarie : There has never been more capital in search of infrastructure

17 Jun 2016

This article is an opinion piece written by Grant Smith, Head of Infrastructure - Australia at Macquarie Infrastructure and Real Assets. It was first published in the Australian Financial Review and can be found at the following link.

Evolving out of privatisation programs in the United Kingdom and Australia more than 30 years ago, infrastructure continues to emerge as an investment asset class as governments around the world look to infrastructure - and private sector investment - to increase productivity and growth.

Investors who have allocated capital to infrastructure over that time have done well. Valuations have, overall, continued to move upward, supported by capital inflows and historically low interest rates. However, continued increases in valuations beg the obvious questions: is infrastructure now overvalued; and can the asset class continue to deliver adequate risk-adjusted returns?

With respect to the first question, the path for global interest rates will of course be very important for almost all global assets. But in the case of infrastructure, two key forces remain at play, both of which could support valuations.

Firstly, inflows into the infrastructure asset class are still growing. There has never been more global capital seeking to invest in infrastructure, and communities around the world, especially those with a clear record of respecting the rule of law, are being offered an unprecedented level of capital to improve the quality and productivity of their communities.

Secondly, higher valuation multiples are the flip side of the low interest rate coin. Many investors instinctively expect 'mean reversion' for interest rates, challenging future valuations including infrastructure. Indeed, many investors have been expecting this for more than 30 years and some are now asking if interest rates may remain very low for a longer period of time.

An obvious reason for the current low interest rate environment is the recovery from the recent financial crisis. But that may not be the whole story. There are other very big and very potent trends at play in the global economy.

There has never been more global capital seeking to invest in infrastructure, and communities around the world, especially those with a clear record of respecting the rule of law, are being offered an unprecedented level of capital to improve the quality and productivity of their communities.

Global savings, in particular pension funds, have never been greater. It has been long understood that people's marginal propensity to consume reduces with increasing income, that is, savings increase as incomes rise. And global incomes have certainly increased, most spectacularly in our region with the emergence of China. Australia's retirement savings growth resembles many developed countries with similar baby boomer demographics, while many countries in our region are even more dedicated savers. Commentators often focus on the unprecedented size of global debt without recognising that it is all owned by someone, mostly it is someone's savings.

Another potent global trend is technological advancement, and its associated productivity and price implications, which could be a game-changer for the global economy. A simple look at our daily lives confirms it. The personal productivity gains that come from transacting via a smart phone are apparent at almost every turn. You can book, pay for and board a plane in Sydney without touching a boarding pass. You can use your Australian Uber account to ride from Heathrow to your Airbnb apartment, lowering the cost of transport and accommodation. The regular aspects of life are becoming faster, cheaper and easier every day.

And the best may be yet to come. Driverless cars and trucks, which some estimates suggest will be in wide usage in only a few years, are expected to result in a significant step-up in productivity and change how we move people and goods. Artificial intelligence, robotics, nanotechnology and the 'internet of things' are just some developments that are likely to be just as potent.

These innovations pose challenges for governments and policymakers. For investors the productivity gains they generate could make them hugely disinflationary for the global economy. As the downward pressure on inflation from weak demand fades, the disinflationary baton could easily pass to these positive supply side developments, helping keep interest rates low.

Over the coming 20 years interest rates could average a fraction of what they have over the last 20. If so, we may perhaps be only part way through an adjustment to higher valuation multiples, not just for infrastructure but a number of other asset classes as well.

Of course valuations are all relative. While infrastructure as an asset class is undoubtedly suited to the current environment, challenges remain for investors seeking to capture superior risk adjusted returns. Beyond understanding macroeconomic forces, having the expertise required to identify the right opportunity at the right time; knowing how to add value to operations; delivering capital investment for the long term under prudent capital structures; and ensuring infrastructure assets are ready for, and adapting to, emerging technologies and trends remain more fundamental than ever to generating sustainable alpha.