The asset class we can't live without

THE ASSET CLASS WE CAN’T LIVE WITHOUT

With its second anniversary coming up in October, M&G Investments’ Global Listed Infrastructure Fund is well placed to celebrate. We get down to detail as we interview the fund’s infectiously enthusiastic manager, Alex Araujo, exploring not only the reasons behind his passion for the sector but also the disciplined processes which he has put in place to ensure that the fund is well positioned for future success

IFAM: Alex, you’re clearly very passionate about investing in global listed infrastructure. Can you explain to us why you think it presents such attractive opportunities and why you believe it should be on advisers’ and investors’ radar?

AA: Infrastructure as an asset class is well-established as a complement to multi-asset portfolios primarily in the private realm. We have observed huge amounts of private capital going into global infrastructure projects and assets over the years. These are investments being made by the likes of sovereign wealth funds, pension funds, endowments and insurance companies etc. where the investment focus is on meeting long term liabilities and with very long term investment horizons. One point of note is that the returns from this sector tend to complement and be generally uncorrelated to other investments held in their portfolios. But private infrastructure investment tends to be for a privileged few. So in a sense, with the launch of our fund in 2017 we have democratised this asset class, providing access to it for investors in a liquid format by way of listed infrastructure businesses with many of the same types of characteristics underlying them as you see in the private realm. It is an asset class which is increasingly gaining acceptance within the investment community. Of course, managers will express their exposure to the asset class in different ways and I think it is important to have a number of different infrastructure strategies for advisers and investment managers to choose from. Like any investment strategy, there is differentiation here and it is important to understand this and to embrace it.

We ourselves aim to invest in businesses with real physical long life assets with reliable cashflow streams and growing dividends. The characteristics which come from these businesses and assets are incredibly complementary and attractive to investor portfolios.

One of the prime characteristics demonstrated by the asset class – and our strategy too – has been its ability to protect capital in more difficult market environments thereby protecting against downside risk. At the same time, because of the way we’re investing and what we’re investing in, we also have the opportunity to capture and participate in any upside when markets move higher. Because of this, I’m sure that advisers can see that we’re not just about offering a defensive strategy here and we are certainly not a bond proxy – which is something of a perception amongst the investment community when looking at this asset class.

IFAM: Infrastructure is a broad term for the investment opportunity set. How do you go about defining your investment universe?

AA: There are a number of different global listed infrastructure strategies operating across the UK investment market place. I believe that these strategies all offer something slightly different and I have the fullest respect for my peer group. Increasingly we are dealing with clients who will initially make a commitment to the sector within their portfolios and then will have exposure to more than one – maybe two or three - different strategies. These can work in a very complementary way. Our own starting point is the more traditional sphere of listed infrastructure, it’s what we call ‘economic’ or ‘core’ listed infrastructure. This relates to utilities, energy infrastructure and transportation infrastructure; but we have added two additional categories to the definition for our strategy to bring the asset class to the modern age.

The first of these additional categories is social infrastructure, which covers facilities required for the provision of health, education and civic services. This category of infrastructure offers similar defensive characteristics to the economic sphere albeit with a different asset base which provides diversification benefits.

The third category in which we invest and the most exciting from a growth perspective is what we call evolving infrastructure, which is built around the structural growth in areas such as communications. We all like to talk about this virtual world in which we live but we have to accept that there would be no internet or mobile communications without the distinct physical infrastructure which makes these modern marvels possible. Whether it is the mobile phone towers or data centres for example, it all matters. We take a broader approach to infrastructure and focus on seeking out growing income streams from the businesses we invest in. We are not just about delivering a high yield for investors though. As an integrated part of our investment process, we also apply an ESG (environment, social and governance) approach to ensure the sustainability of businesses and assets. In broad terms, that’s how I’d summarise the way we define our investment universe.

IFAM: When it comes to the M&G Global Listed Infrastructure fund, how do you and the team go about making asset allocation and stock selection decisions? What’s the investment strategy and process?

AA: We run a concentrated strategy, holding generally between 40 and 50 companies within the portfolio. This means that we have to know and understand these businesses intimately well. We take a bottom-up approach to selecting the businesses in which we invest and only select those with high quality, sustainable, long-life assets that have some form of strategic advantage. Very often there may be a physical barrier to entry which allows us to determine the confidence level in the cashflow stream that we will get from those businesses and the contracts that are behind those streams. We will look for growing dividends, so that we can deliver a growing income stream for our investors. On top of this, the ESG filter is integrated into the approach to ensure sustainability lies at the heart of what we do. We have to ask ourselves what we’re paying for that sustainability and those cashflow streams – so looking at valuations is a critical element. Next, we ensure that we are properly diversified across each of the broad categories of infrastructure in which we invest. There are sub-industries in each category so in total we actually have nine subcategories. Because we operate a global strategy, we are also diversifying regionally.

Interestingly, there are different types of dividend growth that we will get from different businesses. We will diversify across those types too. Some are rapidly growing – such as those in the evolving infrastructure space – others are more consistent but growing perhaps at a rate in line with inflation. Then from some we will get a GDP or GDP plus growth rate in the underlying income stream. We believe it's important that we diversify across a number of different considerations which ultimately link in with those characteristics we talked about earlier, such as downside protection and the ability to participate in rising markets as well.

I should add just a word or two about liquidity. These are companies which are listed on mainstream exchanges

throughout the world with full daily liquidity. Should it ever be needed, we could liquidate this fund completely to 100% cash and relatively easily within a matter of days. There are no privately held investments and no highly illiquid assets.

IFAM: How does the team approach work within the fund?

AA: I work within the income team at M&G. Our approach dictates that we be less focused on the absolute yield, with the emphasis is on the growth in the income stream. We have a number of fund managers who have wide experience in this style of investing and in this strategy. This also came out of the fact that our Global Dividend Fund has more than 11 years of history investing in these types of businesses from the outset. So we know what to look for and what is attractive in these types of business. In fact, there are a small number of overlapping holdings across the four strategies run by the income team. Looking more closely at the Global Listed Infrastructure fund however, I have a dedicated analyst on the strategy. Also, we have a deeper analyst team that covers companies on a sector by sector basis that we draw from and other embedded analysts in the team looking at these businesses too. We also interact quite closely with our private infrastructure group; interactions which are incredibly useful for sharing observations on the asset class, transactions and valuations on transactions etc. We also work with the credit analysts from the fixed income team and collaborate on the businesses we’re invested in. Overall, we feel incredibly well resourced in covering this asset class.

When it comes to interaction with our ESG team here, we have regular meetings and ongoing dialogue with the group. They also assess our portfolios regularly, looking for existing or potential controversies, as well as each company’s direction of travel. Often when we meet with companies, members of our ESG team will join us at the meetings to more deeply engage with the management so that the working relationship is very close. Within our ESG process one thing we don’t do is to take third party rankings and ratings of businesses as a given. We do our own work from an ESG standpoint and we make sure that we are accountable for every holding. We don’t use a negative screening process either as we don’t believe it fully assesses the prospects for a business as it is quite prone to error. However, we do use third party providers as a source, as an input in the same way that we use research analysts who cover our companies. Ultimately though, we do the work ourselves.

IFAM: Is it a constraint having twin objectives of delivering capital growth as well as an increasing income? Where does the emphasis lie?

AA: This is an important question as it’s a both an academic and an ideological one. In fact, we resolutely believe that income growth and capital growth work hand in hand. When we invest in a business, we won’t know how the market will value it over time but we can get a handle on its ability to grow its income stream. If it can do so progressively and sustainably – for example without having to borrow money to pay an increasing income stream – then we believe that capital markets will reward that income value by increasing the equity value of the business. So our ideal investment is a company which consistently grows its dividend over time but that its dividend yield overall doesn’t really change or perhaps even declines – as a result of the capital value adjusting for the value of the sustainability of that income growth. We strongly believe that capital growth and increasing income absolutely are inextricably linked.

IFAM: How do you manage risk in the portfolio and ensure that there is effective diversification for investors?

AA: There are two parts to this. The first one is in the way that we established and built the strategy in the first place. Secondly, there’s the way that risk is monitored and addressed on an ongoing basis in co-operation with our risk team.

So on the first point, we talked earlier about the three broad categories of listed infrastructure and each of the sub categories within those. When we built the framework for allocations to each category and sub-category, this was done following a rigorous assessment of the volatility versus return trade off of the underlying companies in the investible universe of each category. So we built a framework and allocation range to cover these which is embedded in the process.

Broadly speaking, economic infrastructure is between two thirds and three quarters of total exposure, social infrastructure is between 10% and 20% and evolving infrastructure between 15% and 25%. These ranges were established to minimise risk and maximise return. The position size, weighting target etc. build up to that. Finally, there’s the regional element of diversifying via a global strategy and making sure that we have a mix of business and regulatory risk – as many of the businesses have some form of regulatory oversight whether it is moderate or comprehensive.

IFAM: Looking ahead, where to do you see the most attractive investment opportunities within the sector?

AA: I must admit that I’m very excited about all the opportunities we have right across the portfolio and that we have confidence in each of our holdings across all of the categories. That said, from time to time, the market throws up wonderful opportunities. At the moment, I see particular opportunities in energy infrastructure. The market can become concerned in the short term about the industry and sector, which creates buying opportunities which we can capitalise upon. We’ve been steadily increasing our allocation here and now have five holdings which amount to roughly 16% of the portfolio overall. The other area where we see particular ongoing opportunity is in transportation infrastructure where there is significant upside for capital investment for the companies underlying the exposure. Ultimately, this makes for strong return potential and for a growing income stream from these projects. We’ve been adding exposure here too. Finally, the structural growth which is inherent in communications infrastructure keeps us excited about this component of the strategy. We are getting very high rates of growth in cashflow streams from businesses associated with the digital economy which is increasingly pervading our lives. The investment case is compelling.

IFAM: How has the asset class fared through the market’s ups and downs recently? Does it offer any particular characteristics that may appeal to investors?

AA: Listed infrastructure’s outperformance during turbulent times is not just a reflection of market sentiment which can be fickle; the resilience of the asset class is justified by solid fundamentals and the operating performance of individual companies. There is empirical evidence to demonstrate the resilience of these business models, arising from the critical nature of underlying assets. History shows that the cashflows (illustrated in fig 1 by EBITDA) generated by listed infrastructure businesses and the dividends paid from them remained relatively stable during the financial crisis before resuming their upward trajectory.

Over the last few years we’ve done some work breaking down the market’s returns into various episodes and looked at how the strategy has performed and why – and where the performance has come from – in each of those episodes. Broadly speaking, what we found was that when the wider equity market finds itself in a difficult period – for example in Q4 of 2018 or more recently the month of August this year – these are the environments where this asset class really shines. In the case of August, we saw the strategy increase capital whilst the overall market was down. Of course, that was only one month but it is an indicator that this asset class at the very least provides downside protection and preserves capital which is a great starting point for when markets start to recover. When this happens we aren’t left behind, we are able to participate as we are invested in businesses which have underlying growth characteristics and can grow their income streams. There are certain types of markets – what I call the ‘go-go markets’ - when there is much excitement in sectors such as technology which people get drawn to. We won’t necessarily keep up in these times, with those of course, but we can still participate in the upside. Over the long term, these characteristics of downside protection along with strong growth prospects on the upside, allows the strategy the potential to outperform and with lower volatility than the broader market.

In both scenarios, we’ve found that the contribution comes from different places at different times within the portfolio. This really emphasises the importance of diversification across the various categories in which we invest and helps us to offer a more robust solution for investors.

Finally, we’re excited by the increasing interest we’re seeing from our clients. The strategy's assets overall are already well over £200m, having started from a very low base. I’m pleased to say that I was the first private investor in the fund because I want to be completely aligned with our investors in delivering on our objectives. I also want to enjoy the prospects for growth and rising income to help me to deliver on my own objectives for the future.

About Alex Araujo Alex Araujo has been the manager of the M&G Global Listed Infrastructure Fund since it launched in October 2017, and was appointed manager of the M&G Global Themes Fund in January 2019. Alex initially joined M&G’s income team in July 2015 and became co-deputy manager of the M&G Global Dividend Fund in April 2016. Alex has 25 years of experience in financial markets. He graduated from the University of Toronto with an MA in economics and is a CFA charterholder.