Infrastructure has become fashionable in institutional circles during the current low interest rate environment. The returns are attractive and there is a range of projects to choose from. There is also the promise of a hedge against rising prices, but the buffer may not be as strong as anticipated.
“There is a positive correlation, but it [infrastructure] does not perfectly track inflation. This is why we look at infrastructure as inflation protection rather than a straight hedge.”
Vivian Nicoli
In many ways, this perhaps does not matter as much because inflation has not reared its ugly head as forecasted. In fact, the rate remained the same at 2.7% in the UK in September. However, many market participants believe it is only a matter of time. As a recent report from JP Morgan Asset Management (JPMAM) entitled Infrastructure Against Inflation notes it may not be a problem today, but it could become a much more pressing matter over the medium to longer term.
According to Serkan Bahçeci, head of infrastructure research, global real assets group and co-author of the report, along with Robert Hardy, investment principal infrastructure investments at JPMAM: “Major central banks have followed zero interest rate policies while providing additional liquidity using tools such as quantitative easing. If and when the velocity of money returns to historical levels, this amount of extra liquidity ought to create inflation – unless the central banks can simultaneously and perfectly time their efforts to reduce the money supply.”
Infrastructure has always been seen as one way to hedge inflation but the studies are thin on the ground and vary in their findings. One reason is that many of the deals are in the private realm which makes historical data difficult to uncover. Another problem, as Bahçeci notes, is that inflation has really not been an issue in the US, eurozone and other major countries in the Organisation for Economic Cooperation and Development (OECD) over the past 30 years. It has hovered around 2% to 3%, rising to 4% in extreme situations.
This explains why the authors of the JPMAM study had to trawl back 30-plus years to the last high inflationary period – between 1970 to 1985 – to find a link. This was a time when the consumer price index in the US grew at a 6.5% compound annual growth rate (CAGR) interspersed by double digit figures in the years 1974, 1979 and 1980. External shocks such as the crude oil price spikes and lax monetary policy were the main culprits, but the economic situation was not helped by three recessions in 1974, 1980 and 1981-1982.
“We developed a group of alternative indices and found that real estate and infrastructure, especially regulated utilities, outperformed equities and fixed income during that 15-year period,” says Bahçeci. “Our study also showed that commodities, which are typically considered to be an inflation hedge, performed poorly over the long term but did well when there was a panic situation such as the oil crisis.”
Inflation hedge – fact or fantasy?
A paper published last year, Infrastructure as Hedge Against Inflation – Fact or Fantasy? by Maximilian Rödel and Cristoph Rothballer of the Technische Universität, München, had a different perspective. It showed that the asset class including its subsectors telecommunication, transport, and utilities did not hedge inflation particularly well or any better than equities.
The academics used a proprietary data set of over 1400 listed infrastructure firms and matched this with a comprehensive set of inflation data across 45 countries and 30 years. Only portfolios of infrastructure assets with high pricing power exhibited a slightly superior, yet not statistically significant, hedging quality at a five-year investment horizon. Their conclusion was investors should “depart from the belief that infrastructure generally provides a natural hedge”. They found Treasury Inflation-Protected Securities (TIPS) or gilt-linked bonds followed by short-term high-quality bonds and commodities were better options. The bottom line for fund managers is for investors to be discerning.
As Vivian Nicoli, partner of UK-based EISER Infrastructure Partners, notes: “If you look over the longer term horizon, there is a positive correlation but it does not perfectly track inflation. This is why we look at infrastructure as inflation protection rather than a straight hedge. It’s also important to note different assets in infrastructure have different linkages. It depends on asset class and the asset itself.”
Comments