Infrastructure: a deep dive into asset classification

The experience of Six Park’s Investment Advisory Committee is critical to our service. The committee meets regularly to consider asset allocation for our portfolios, review new ETFs to ensure we continue to use the best ETFs in Australia, and monitor the financial and political landscape around the world.

At its recent regular meeting, the investment committee devoted considerable time to analysing the performance of infrastructure as an asset class in recent months. As a result, the committee adopted a new definition of infrastructure’s “classification” as an asset in our portfolios.

Is Infrastructure a Growth Asset or Defensive Asset? Or both?

Different asset classes serve different purposes within a portfolio. Some are very easy to identify – for instance, shares are a growth asset, while bonds are defensive.

Other asset classes are less straightforward and may not be purely growth or defensive.

Like most asset managers, Six Park has previously categorised infrastructure as a defensive asset class. But this has been challenged by infrastructure’s underperformance during the past six months when COVID-19 has significantly disrupted particular industries.

Six Park’s investment committee has reviewed infrastructure’s performance as well as analysing the broader industry view of infrastructure during this period and has adopted a 50-50 growth/defensive weighting of infrastructure going forward.

Infrastructure Asset Classification Approaches

• There is no universally accepted approach to the classification of infrastructure as a growth or defensive asset. This is partly because the sector has (at least historically) exhibited both growth and defensive characteristics – and does not fit neatly into either category.

• Certain infrastructure assets (particularly those with highly regulated pricing and predictable demand) share many of the defensive characteristics of bonds (e.g. stable earnings, inelastic demand, low or negative correlation with equities). Other infrastructure holdings (particularly those reliant on usage) tend to behave more like equity investments. To complicate matters, infrastructure companies often own a range of assets that have varying risk characteristics.

• In December 2019, APRA released an information paper (“Heatmap – My Super products”) which outlined how it intended to identify and highlight underperforming superannuation funds. As part of this work, APRA noted it would be applying a “100% growth” classification to listed infrastructure in comparing net investment returns across a peer growth allocation trend line and versus a simple reference portfolio. APRA has also elected to apply a 75% growth weighting to unlisted infrastructure. This approach is not technically a classification requirement, nor does it apply directly to non-superannuation entities.

• ASIC has provided limited guidance on this matter, although it does note that defensive assets are traditionally classified as cash (or cash equivalents), and fixed interest on its consumer and investor website Moneysmart.

• Although IFRA’s underperformance of late has raised questions over its characterisation as a defensive asset, much of this underperformance is a function the steep declines in 2 specific subsectors (transport and pipelines) which have been heavily impacted by the highly unusual flow-on effects of a 1-in-100 year pandemic, rather than a pure sector-wide sell-off

• Given IFRA’s portfolio comprises a mix of holdings with varying “defensive” and “growth”-like characteristics (as evidenced by its mixed underlying sub-sector performance of late), we believe it is prudent to move away from a “100% defensive” classification.

• At the same time though, we do not believe that the sector should be classified as 100% growth either, especially given the resilience of certain elements of the asset class.

 IFRA analysis

• Six Park’s portfolios use Van Eck’s IFRA ETF for exposure to infrastructure, as our investment committee believes this is the best ETF in Australia for this asset class.

• IFRA has performed poorly during the COVID-19 crisis, falling -12% in the year to date compared to VGAD’s decline of -4%. This underperformance has raised questions over its characterisation as a defensive asset.

• As outlined below, IFRA’s underperformance is a function of the diverse composition of the underlying index that it tracks (FTSE Developed Core Infrastructure 50/50).

• The FTSE Developed Core Infrastructure 50/50 index comprises about 150 constituents which (i) are deemed to operate in the infrastructure sector according to FTSE’s classifications and (ii) generate at least 65% of their revenues from these sectors. The weight of each eligible company is capped at 5% per individual stock and sub-sector limits operate to cap exposures to a maximum of 50% utilities, 30% transportation and 20% other (e.g. pipelines)

• There has been a wide divergence in YTD performance among the different infrastructure sub-sectors, with utilities stocks holding up reasonably well but more than offset by steep declines elsewhere. This is particularly the case across transport, which has been heavily impacted by the imposition of lockdowns and travel bans, and pipelines, which have been sold off on concerns relating to the demand from their key customers.

• Of the 12% decline YTD, roughly half can be attributed to the fall in transportation stocks (which although only comprising 21% of the index, have fallen -29.7%). A further -2% of the decline is linked to pipeline stocks.

• Over the past 12 months, IFRA is down -8.4% (to the end of July).  Of this decline, -6.2% is attributable to the transport sector (which has fallen -30% over the period) and a further -1.6% relates to the decline in pipeline assets (which are down -18%).

Impact of infrastructure reclassification on Six Park’s portfolios

• The impact of reclassifying infrastructure’s defensive/growth categorisation on Six Park’s portfolios is shown below.

• Given IFRA’s portfolio comprises a roughly equal mix of holdings with varying “defensive” and “growth” (as evidenced by its mixed underlying sub-sector performance of late), Six Park believes it is prudent to move away from a “100% defensive” classification. The latter was an approach that reflected the sector’s performance prior to the pandemic (e.g. 0.55 and 0.19 correlation to Australian and global equities over the five years from August 2011 to July 2016).

• However, we do not believe that the sector should be classified as 100% growth either. While recent performance has been poor, this is largely due to the highly unusual flow-on effects of a 1-in-100 year pandemic (which has generated a near-complete shutdown in transport industries) rather than a typical down-market event (akin to the GFC, where infrastructure assets generally held up very well).  Various companies within the asset class have also proved to be resilient (and highly defensive) over the downturn (albeit not sufficiently so to offset steep declines elsewhere).

• For these reasons, we consider a 50:50 growth/defensive weighting to be an appropriate classification position to adopt moving forward.

• Finally, while the change in classification is relevant in the way our IAC reviews asset classes, generally, we have not changed our view of the expected returns and volatility of infrastructure as an asset class over time, or the role it plays in our portfolio construction. Therefore, this classification change has not precipitated any changes to our portfolio asset allocations.