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Infrastructure in a rising interest rate environment…
(pictured: Greg Goodsell)
Contrary to common belief, a new study has shown, listed infrastructure stocks do not necessarily behave like bonds all the time. You can still make money from them as global bond yields head north… eventually.
The study, by 4 Dimensions Infrastructure, examines key aspects of the notion that listed infrastructure stocks are a close proxy for bonds. It finds that, contrary to common belief, infrastructure stocks can outperform when interest rates start rising.
Greg Goodsell, the global equity strategist at 4 Dimensions Infrastructure, says: “We believe … key characteristics of many infrastructure stocks, especially the inflation protection in user-pay assets, facilitate earnings growth in a rising interest rate/inflationary environment.
“We contend that earnings from such stocks are not ‘fixed’, as is common belief, but rather often have a positive correlation with rising interest rates and inflation.”
Goodsell and co-founders Sarah Shaw and Michael Morrison set up the infrastructure fund management firm last year under the Bennelong Funds Management umbrella.
Goodsell says: “Clearly, there is more to the relationship between rising interest rates/inflation and the performance of infrastructure stocks than is commonly perceived…
“Firstly, infrastructure stocks substantially outperformed following the commencement of the last [US] Fed rate hike cycle. While there has been only one such period since 2001, it was an extended cycle seeing rates rise from 1 per cent to over 5 per cent between May 2004 and July 2006.
“Secondly, infrastructure stocks have illustrated a pattern of under-performance followed by outperformance following the commencement of each of the three periods of rising T-Bond yields since 2001. We believe that both of these strong performances by the S&PI can be attributed to the unique earnings characteristics evident in many infrastructure stocks – in particular user-pay assets with their ‘all seasons’ earnings attributes.”
The other major category of infrastructure stocks – utilities – has different forms of earnings protection, such as frequent regulatory reviews where approved prices and volumes are reset as a result of changes in bond yields or inflation, the research note says.
“Accordingly, our strong contention is that earnings from infrastructure stocks are not ‘fixed’ as is common belief. Rather they can offer built-in protections which result in earnings, especially in user-pay assets, that often demonstrate a positive correlation with rising interest rates and inflation.”
The varied stock performance during the study period across differing macro-economic backdrops demonstrates the importance of active portfolio management, Goodsell says, and the ability to appropriately position an equity portfolio for the economic circumstances of the day.
