Robin Jakob, Co-Founder, LPX AG
Inflation and interest rates have dominated the investment agenda in recent years. Certainly, there has not been much refuge for investors through this difficult market environment. The volatility of traditional markets – equity and bonds – has been well documented. These securities have had a rocky ride over the last couple of years. The pandemic and the economic halt it brought with it was one thing, but subsequent soaring inflation and aggressive rate hikes have seriously dampened the valuation of fixed interest securities and many equity sectors. These securities were and still are the engine of many discretionary portfolios.
So, where is the refuge for a portfolio manager to turn to safely navigate this choppy, unpredictable environment for their clients? Our data shows that the core infrastructure asset class is worth consideration.
Defence and diversification
Over the past 30 years, we have found that core infrastructure has demonstrated attractive long-term risk and return characteristics. This is particularly evident in volatile markets.
Think about the core infrastructure asset class like being like one of the best defensive stocks. The key quality about it is the long durability paired with inelastic demand for the goods and services provided. Additionally, the asset class is characterised by cashflow streams that are predictable and comparatively stable over time. For investment decision making, the risk and return menu and diversification benefits are among the most basic characteristics in which investors often require.
Earlier I mentioned ‘the past 30 years’, and in this timeframe, the infrastructure asset class has outperformed the broad c on several fronts. This chart below displays this.
“The infrastructure asset class has demonstrated attractive risk adjusted returns when compared to broad equity market even over a long-term investment horizon.”
Cumulative Total Return from 26.02.1993 – 28.02.2023 for NMX Infrastructure Composite Net TR (Core Infrastructure) and MSCI World Net TR (World Equity) in USD.
Performance in volatile markets
Earlier I also mentioned that the core infrastructure asset class tends to perform well in volatile environments. We have accurately assessed this using the National Bureau of Economic Research (NBER) business cycle classification to determine meaningful time intervals that reflect contraction and expansion market phases, and compared this to the broad equity market.
“The infrastructure asset class has generally exhibited better performance than public markets during most business cycles over a 30-year observation period.”
The infrastructure asset class shows a geometric mean return of 9.3% over the 30-year observation period with a corresponding standard deviation of 14.4%. In comparison, the traditional equity market shows a performance of 7.40% and an annual standard deviation of 15.3%. Proxies: Core Infrastructure: NMX Infrastructure Global Net TR; MSCI World: MSCI Word Net TR. Source NBER : https://www.nber.org/. Currency: USD.
The data confirms that the core infrastructure asset class has demonstrated strong outperformance during most business cycles over the past 30 years when compared with the traditional equity market. Moreover, the asset class has shown an average level of volatility that is significantly lower than that of the broad equity market. This could indicate comparatively low correlation to traditional equities in-line with the perceived investment characteristics of this very asset class.
For the infrastructure asset class and the broad equity market, a month is classified as an “up-up” market if both market returns are above average (i.e., positive semi-correlation), whereas a “down-down” market is defined as a month where both returns are less than average (negative semi-correlation). Correlation coefficients are determined for up-up and down-down markets. The average correlation with the broad equity market as proxied by the MSCI World is 0.8 over 30 years observation period. The positive and negative semi-correlation is 0.59 and 0.76. The empirical result suggest that the infrastructure asset class provides sufficient diversification benefits even in contracting market phases.
“The correlation of the infrastructure asset class compared to the broad equity market is not increasing in contracting market phases, which suggests sufficient diversification benefits in a challenging market environment.”
So, to conclude, over the long run, we believe core infrastructure is an asset class certainly worth consideration in both the retail and institutional asset allocation mix. Although past performance is certainly no indicator of the future, empirical results suggest that the core infrastructure asset class tends to provide a softer landing for portfolios in more challenging markets.
