Kempen Outlook 2021 Infrastructure outlook

  • There’s huge need for infrastructure around the world, driven by a number of megatrends such as digitalisation, the energy transition, urbanisation and smart cities
  • Short-term volatility creates opportunities to take exposure to long-term trends 
  • We believe that the crisis has accelerated existing trends – the most obvious being the remote economy, supporting digital infrastructure valuations
  • We continue to see value in utilities focused on the energy transition as renewables have become more competitive
  • Transportation infrastructure has had a challenging year, but there is still selective value to be found as the risks the sector involves are now better reflected in valuations

Infrastructure equities performed extremely well in 2019, with our infrastructure fund up more than 30% over the year – not bad for an asset class providing stable, predictable cash flows. It continued in a similar vein at the start of 2020, but then coronavirus hit and things became more volatile. So after a turbulent year, what factors should infrastructure investors be looking out for in 2021?

Although the listed infrastructure market will probably remain volatile in the short term, the potential for infrastructure investments is obvious over a longer time horizon. There’s huge need for infrastructure around the world, driven by a number of megatrends such as digitalisation, the energy transition, urbanisation and smart cities.

After the vast amount of monetary stimulus to support the global economy we’ve seen in recent years, we’re likely to see more fiscal stimulus next year. Infrastructure investment is an obvious way of further boosting the economy. 

In the US and Europe, existing infrastructure will have to be improved and new assets will have to be built. And of course there’s likely to be huge further infrastructure investment in China, where USD 2.5 trillion of infrastructure investment is planned over the five years to 20251 across a range of sectors. China has recently committed to go carbon-neutral by 2060 – a huge undertaking.

While governments will invest heavily in infrastructure over the coming years, private investors will have to play a more prominent role in financing new projects because government balances are already stretched. 

We’ve already seen significant growth in private investments into the infrastructure market over the past decade, and there’s still a lot of capital waiting to be deployed. With interest rates so low, and the broad equity markets having undergone considerable multiple expansion, many investors are likely to be attracted to the predictable cashflows that infrastructure investments generally provide. In many cases it also represents an opportunity to invest in environmentally and socially responsible initiatives. 

With more capital flowing into alternative investments and real assets, investors will have to consider how they want to take exposure to infrastructure projects – whether by investing directly in the assets themselves or by investing in firms that are listed at the stock exchange. 

Perhaps most importantly for investors, listed is still trading at a discount to non-listed infrastructure. The gap in the prices between listed and non-listed infrastructure is only partly justified, in our view, and the reasons for its existence are diminishing. The discrepancy has increased as a result of the coronavirus, mainly because of falling share prices, while non-listed prices have held up strongly. We believe this makes listed infrastructure a particularly attractive opportunity in 2021.

As bond yields have fallen there’s a bigger case for increasing the allocation to alternatives within an investment portfolio in 2021. Infrastructure offers an attractive risk premium and provides exposure to secular megatrends that have clear long-term return potential regardless of short-term volatility.

But it’s important to bear in mind that infrastructure should really be seen as a long-term investment rather than somewhere to make a quick gain. We take a ten-year view in the companies we invest in, which gives us the chance to exploit arbitrage opportunities created by short-term equity investors. For example, many equity investors might have ditched some companies earlier in 2020 because they were worried about short-term passenger trends, but we looked upon the resultant fall in the share prices as a long-term opportunity.

One of the beauties of infrastructure is that although its definition stays the same, what constitutes infrastructure can vary over time. Ten years ago, data centres and clean energy would probably not have been considered to be infrastructure as they didn’t provide crucial services to society, but today they qualify because they’re vital. And in the coming 5-10 years there will probably be new investments that qualify as infrastructure, creating new opportunities for us to invest in.

Battery storage is one such area. We believe it will be seen as vital over the next few years as an add-on for solar and wind farms to cover the mismatch between supply and demand for power. Good battery storage will make sustainable forms of energy more competitive relative to fossil fuels. 

In 2020, the global pandemic has had a major impact on the financial markets, including the listed infrastructure market. With both supply and demand affected, there have been major consequences for certain infrastructure assets. Around the world, traditional infrastructure like airports and toll roads faced a collapse in passenger numbers (although toll roads have experienced a V-shaped recovery). Meanwhile, the relatively inelastic demand for utilities and communication infrastructure meant these companies were more resilient than those involved in transport infrastructure.

However, how we use infrastructure might be set to change fundamentally. We believe that the crisis will accelerate certain trends, the most obvious being the remote economy. Since the beginning of the lockdown, society has increased its use of digital infrastructure – a trend that we have been taking exposure to in our portfolio since its launch – and the lockdown acted as an unexpected adrenaline shot for this societal shift.

Let’s take a look at some of the factors that are likely to affect the various infrastructure sectors next year and further into the distance.

Utilities have done well: the payments that grid operators receive just for making their networks available made their cash flows more resilient, while people using more energy at home offset (partly) the reduced energy consumption of businesses during the lockdown. 

With governments around the world committed to minimising climate change and meeting the goals of the Paris Climate Agreement, clean energy projects could be particularly attractive investments over the coming years. Recognition of the lack of progress towards meeting the Paris goals and the United Nations Sustainable Development Goals has resulted in increasing regulation and renewed ambition to succeed, as we have seen with new Green Deals on climate issues. 

We believe infrastructure will play a crucial role in the energy transition and fostering sustainable growth. Many of the challenges linked to the energy transition and achieving the United Nations Sustainable Development Goals will be met through infrastructure investments. Significant investment will be required to change the energy mix and facilitate greener transport. 

But going green doesn’t just mean switching to renewables – we also believe that gas has a role to play in the energy transition (gas emits less than half the CO2 that coal does in power generation). We’ll therefore be continuing to look for opportunities in gas pipelines, as these are the most environmentally friendly and safest way of transporting gas between where it’s extracted and where it’s needed. 

As long-term investors, we will see the risks and opportunities linked to sustainability becoming more material in our investment opportunities. We reward companies that are more advanced on the road towards sustainability, and we expect the market to focus on utilities that are rotating their portfolio towards renewable energy. 

The need for data centres and communication towers has continued to grow in 2020. Data consumption has been going through the roof in recent years with the moves from 3G to 4G and now 5G, and this megatrend looks set to continue for years to come. During the lockdown there was huge demand for data as people watched TV and films on streaming services, held business meetings and family reunions on online platforms such as Zoom, and played video games with their friends online. Meanwhile, edge computing, the Internet of Things and the Cloud are all going to drive further demand for data, which needs to be stored somewhere. And that’s good news for investors in data centres.

Back at the start of the year, all long-term outlooks were suggesting that the number of aeroplane passengers would double over the coming 10–20 years due to the growing global population and people getting richer in emerging markets. In the US, the average person took 2 flights per year, while in Europe the figure was 1.5. By contrast, it was just 0.1–0.2 in China and India. While no one was suggesting these two countries would reach the levels of the US and Europe, there was clear scope for the number of flights there to grow massively.

But then the pandemic struck, and during the lockdown airport passenger numbers were down by 90–95% in March and April. Neither did they recover particularly strongly afterwards – they were still down around 60% year-on-year in the summer holiday period – and have weakened again as Covid-19 cases have picked up again. It’s hard to see how they’ll get back to their previous level until a vaccine becomes available.

Passengers on toll roads also fell sharply during the large-scale lockdowns in March-April, but as soon as lockdowns ended the number of vehicles travelling on them recovered quickly. They also benefitted from many people deliberately avoiding public transport.

At the start of this year we thought airports were expensive so we were underweight, and favoured toll road investments. But now we’re trying to understand the impact of the pandemic on passenger numbers, looking at company balance sheets and liquidity to determine the right time to increase exposure to airports. But with business travel unlikely to recover to previous levels, we’re being forced to reconsider our investment theses and have been focusing on airports with more exposure to domestic and short-haul flights (such airports have done relatively well in Asia in recent months). 

The biggest risk for 2021 is an extended second wave of pandemic, with large-scale lockdown. This would have long-lasting economic impacts and hit public health systems. 

From an infrastructure investor’s perspective, this would impact passenger volumes at airports and the number of cars on toll roads, but it could also lead to a rise in populism, which could create uncertainty about the assets we’re buying into. For example, there was a risk of water companies or electric companies being renationalised with the past elections in the UK. Such developments wouldn’t just affect the companies in question, but also sentiment towards the country they’re located in. This makes it important to invest with an active manager who can monitor the regulation and consider potential changes to laws, and include these factors in each company’s investment case. We’ll therefore be paying close attention to elections next year – both in the US and Europe. 

We’ll also be paying very close attention to the physical risk our investments are exposed to. We hold very detailed microlocation-level data on where natural disasters such as hurricanes and wildfires have occurred, and use projections about future disasters to ensure we underwrite our investments properly.

Regardless of these concerns, infrastructure has shown its defensive characteristics in previous periods of turmoil. For example, it held up better than many other risky assets during the periods of volatility linked to concerns about trade war in 2019. This shows that infrastructure is primarily driven by local demand rather than what’s going on in the wider world. 



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The Author

Thomas van der Meij


The views expressed in this document may be subject to change at any given time, without prior notice. Kempen Capital Management N.V. (KCM ) has no obligation to update the contents of this document. As asset manager KCM may have investments, generally for the benefit of third parties, in financial instruments mentioned in this document and it may at any time decide to execute buy or sell transactions in these financial instruments.

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