The income component benefits from assets providing essential services, enjoying high barriers to entry and strong pricing power.
The growth component reflects structural drivers such as urbanisation, globalisation, mobility, energy security and the shift in assets from public to private.
Global listed infrastructure has shown over the past 15 years (and the past three years through the global financial crisis) that these attributes can translate to higher returns with lower risk than general equities.
While it seems logical to match long-dated liabilities with long-term assets, investors need to be confident their companies are being managed for the next decade, not just the next quarter.
Sustainability issues are more important for infrastructure companies than many other sectors. For example, environmental issues present risks for coal-fired power stations but present opportunities for electricity transmission, extending to renewable energies.
Social awareness can maintain customer satisfaction at airports and reduce political risk in regulatory outcomes. Governance is critical if toll road companies want to avoid trading below intrinsic value.
We believe environmental, social and governance (ESG) issues impact on infrastructure stock performance and should be fully integrated into an investment process.
We do not screen companies on ESG criteria, but seek to understand the risks and capture them in a proprietary quality ranking.
In practice we require a higher return for companies that fall short. This process has proved valuable as infrastructure companies that have ranked higher on ESG criteria have been more defensive.
The potential impact of infrastructure companies on the environment is varied.
Electricity generation is responsible for 30 per cent to 40 per cent of the world's carbon emissions. Generation fleets biased towards nuclear, hydro and wind offer a significant cost advantage to coal, oil and gas generation, particularly as countries implement carbon pricing schemes.
Some companies are taking active steps to replace coal-fired power stations with renewable energy and invest in research and development of carbon capture and storage technologies.
Others are waiting for governments to force the change or are trying to deflect the issue through financial contracts - short-term responses to a problem that is unlikely to go away.
Other areas of environment risk for infrastructure companies include fuel spills from storage tanks, access for pipelines through protected wilderness areas and dredging to improve port access.
We have also seen some positive outcomes for infrastructure companies on the environmental front. Replacement capital expenditure to improve electricity losses and water leaks has underwritten solid earnings growth for utility networks.
Subsidies offered on renewable energy investments have cushioned the declines in wholesale power prices. A new generation of aircraft, such as the A380, uses airport runways and terminals more efficiently. Investments in new motorway and rail infrastructure are significantly reducing congestion on some routes.
Most infrastructure assets are in privileged positions. Provision of an essential service with limited competition means they are also likely to face a high level of public scrutiny, particularly if they abuse this privilege.
It is important for infrastructure companies to consider all stakeholders - staff, community, customers, suppliers, regulators - if they want to maximise long-term returns to shareholders.
Social issues that impact on infrastructure companies include staff turnover and injuries, community impacts from noise or pollution, customer satisfaction and engagement, meeting suppliers' needs for access and efficiency, and maintaining healthy relationships with regulators.
Mismanagement of just one of these issues could impact another, for example, where poor customer satisfaction leads to significant political pressure on regulatory outcomes.
Infrastructure assets can deliver strong free cash flow to investors with relative certainty. But this certainty at the asset level can be offset by high financial leverage or aggressive acquisitions at the company level.
This in turn may lead to stocks trading at significant discounts to intrinsic value. The board plays a critical role in ensuring that certainty translates from the asset to the stock. Boards must set a clear strategic direction, align management incentives and maintain transparency.
The interests of numerous stakeholders can lead to poor governance of infrastructure companies. Boards of a number of European utilities are dominated by government or employee representatives and provisions exist to defend takeovers.
In China, infrastructure companies tend to be controlled by a provincial government or entrepreneur, with shareholder returns tending to be higher for the latter. A number of Australian infrastructure companies were represented by the investment bank that also owned the management company, a clear conflict of interest and potential risk to investors.
Infrastructure and ESG issues
Sustainability issues are important for many infrastructure companies.
Mismanagement of these issues can clearly impact on the sentiment towards a company, but may also have a direct effect on profits through customer losses, regulatory outcomes or political intervention.
Overall, consideration of ESG issues as a fully integrated part of the investment process can deliver more defensive returns for infrastructure investors.
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