First State Investments Head of Listed Infrastructure, Peter Meany, has been in New Zealand this week updating clients on the sector.
He says the two biggest risks infrastructure faces are firstly political and regulatory changes and secondly rising bond yields. Both these have hit the sector at the same time with Brexit and the election of Donald Trump as the US President-elect, and the subsequent increase in interest rates.
"The two areas of risk for our fund have played out at the same time. Valuations have come back."
Meany says they had been expecting interest rates to rise, but in 10 days they went up what we expected to happen over 10 months.
"We were ready for a rise in bond yields but it came more quickly than expected."
While the Trump victory took the markets by surprise, Meany says there has been "a lot of noise and an overstating of the risk"
In the United States 80% of the infrastructure decisions are made at a state, rather than Federal level.
He says the best way an infrastructure fund can protect itself against political risks is to diversify.
Meany says the fund has no New Zealand assets. It covers Auckland Airport, which he describes as "a terrific asset, it's really well-run, it's really expensive particularly compared to other airports around the world which are half the price."
"The New Zealand electricity market is way too volatile and there is a structural issue there. You produce power in South Island and consume it in the North and you have a dodgy link in between."
"You can't naturally hedge a utility in New Zealand," he says.
The Colonial First State Global Listed Infrastructure fund has assets under management of $7.8 billion. It aims to generate an 8-10% total return each year. made up of 3% to 4% yield and 5% to 6% growth.
The NZ PIE version of the fund has returned 16% annually since inception; 12.6% in the past year and it is down 1.8% in the past three months due to political events and rising bond yields.
Meany says at first investors used listed infrastructure to replace or compliment property, as property, during the GFC proved to be not as defensive as they thought.
With changes to the fixed interest sector investors started replacing bonds with defensive equities. Meany says it was an income play, and a less risky one than a general equity income investment.
Now investors, particularly pension funds, are allocating around 15% of their investments to real assets and listed infrastructure accounts for 4-5% of that allocation.
"It's a core part of their strategy now," Meany says.
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