FOCUS - M&G M&G Investments, infrastructure fund

M&G’s Alex Araujo on why global listed infrastructure provides a compelling proposition for long-term investors looking to diversify

For investment professionals only

WELCOME

M&G’s Alex Araujo presents a new listed infrastructure fund that offers the characteristics of higher dividend yield and lower volatility compared to global equities, as well as exposure to inflation-linked revenue streams. Infrastructure is a core economic activity, says Araujo, but it is also an essential foundation for achieving inclusive sustainable growth and enhancing access to basic services, education and work opportunities.

There is a wealth of evidence from bodies such as the World Economic Forum on the ‘infrastructure gap’ that exists in both the developed and developing world. Industry experts differ on what the spending requirements should be to plug the gap but, as is now commonly recognised, “the investment needs are significant,” says Alex Araujo, Fund Manager at M&G Investments.

THE INTERVIEW

Capturing income through a powerful thematic

Listed infrastructure:

Alex Araujo

M&G Investments

Araujo runs M&G’s recently launched Global Listed Infrastructure Fund and says the asset class provides a compelling proposition for long-term investors looking to diversify their portfolios. Specialist investors like M&G have bought into a wide range of the world’s infrastructure – ranging from Australian airports to UK water companies with an array of port, energy and telecoms infrastructure in between.

Industry challenge

Investment areas

It follows that big infrastructure projects have the potential to be economically transformative. As a case in point, a recent paper by the Global Infrastructure Investor Association (GIIA) reviewed how in the 1990s, the publicly-owned structure of Australia’s 10 largest airports was starting to hinder their ability to keep pace with the evolution of the global aviation industry. In response, the Australian government decided that investment from the private sector, accompanied by appropriate regulatory oversight, was the best way forward and they proceeded to privatise Australia’s airports from 1997 into the early 2000s. By their nature as essential public services, infrastructure businesses require a lot of effort and ongoing expenditure to keep them operating well, particularly those companies in the sector that aim to meet the needs of expanding cities and increasingly demanding consumers. Often demands extend past the purely practical. Araujo explains: “When you think about infrastructure, you think about businesses with quite significant footprints, whether that’s an airport, a new runway, a motorway; there are environmental challenges there. There are inevitably social challenges around those types of projects. “We integrate ESG considerations at every stage of the investment process and we do that for economic reasons. Investing in long-life, immovable physical assets means that the sustainability of those assets and the businesses that own and operate them is absolutely key. Our investment horizon is very long and when one thinks about regulatory requirements, it’s an important consideration for the underlying risks of those businesses. Regulatory risks vary round the world. One of the benefits we have is that we are globally minded and can invest in many jurisdictions around the world.” The GIIA’s report came to a final analysis that the principal challenges facing the industry, which investors will need to respond to, are: (i) committed asset management, (ii) good governance and (iii) continued investment into new infrastructure. In terms of continued investment, the market place seems to be answering the call. In 2006, there were nine listed infrastructure mutual funds and no listed infrastructure exchange traded funds. As of 2016, there are 66 listed infrastructure mutual funds and 32 ETFs tracking listed infrastructure indices. While infrastructure is a core economic activity, Araujo argues it is an essential foundation for achieving inclusive sustainable growth and enhancing access to basic services, education and work opportunities. “Here in the UK, we are fortunate enough to mainly face challenges on our motorways, our airports and in public transit. But elsewhere in the world, the issues can be more severe: water quality and reliability of the electricity supply are front-and-centre issues for many people in many countries, encompassing the developed world as well as emerging markets.”

“Much of the world’s core infrastructure, especially in developed economies, was built several decades ago and it hasn’t caught up with modern day requirements” he says. “The investment need applies not just to the capacity but also as a way to serve society and a growing world economy. More critically, investment is needed to address the safety risks posed by this steadily deteriorating capital stock.” Flows into global infrastructure assets hit a record $413bn in 2016, a rise of 14% on the year before. Yet it’s an asset class that hasn’t always been accessible to retail investors and has been marred by liquidity concerns. Listed infrastructure products have helped remedy these fears amid a growing demand for real assets that offer relatively predictable cashﬂows, and the potential for attractive real returns. Finding infrastructure assets with solid economics has required a change to traditional ways of working and the available liquidity in the listed space has allowed investors to invest in the companies, sectors and regions where opportunities arise. Transport is one sector that managers such as Araujo are watching keenly. As noted by the OECD in their 2017 Transport Outlook report, an efficient transport infrastructure can improve market accessibility, create employment, promote labour mobility and connect communities. “Transportation infrastructure is a key area in need of investment,” explains Araujo. “Many of the world’s motorways, air travel requirements and public transit networks are quite challenged by congestion.”

Source: M&G, PCR team, 25 August 2017

Source: M&G, 5 October 2017. Based on model portfolio.

Source: M&G, 2017.

Fund Snapshot: M&G Global Listed Infrastructure Fund

Expanding the infrastructure universe to capture long-term growth

Geographical breakdown

M&G’s investment team have a bias towards the developed markets of North America, the UK and Europe. The group deploy a diverse regional approach, including emerging markets (e.g. Brazil). The fund also has exposure to the Asia Pacific region through Hong Kong, Singapore and Australia.

Sector breakdown

M&G has limited exposure to pure service companies (e.g. telecommunications, logistics) whose competitive advantage relies less on fixed physical assets.Economic infrastructure is a core holding, supplemented by complementary assets in social and evolving infrastructure. Utilities, energy and transport sit within the Economic infrastructure bucket. Social contains health, education and security while communication, transactional and royalty sit in the Evolving bucket. The group’s investment team see growth opportunities in evolving infrastructure.

The diversification benefits of infrastructure

Valuation is key to what we do. ESG considerations are integrated into the investment process and diversification across sectors and regions is extremely important to us as well.

What is the fund designed to do?

We wanted to democratise the investment opportunity in infrastructure because the unlisted space has primarily been the preserve of large institutional pension funds and sovereign wealth funds, which are less accessible to every day investors. So we launched the M&G Global Listed Infrastructure Fund in October 2017 to provide investors with the favourable characteristics of listed infrastructure, while also embracing the dividend growth philosophy which is central to M&G’s income team. We see these types of businesses as an alternative to the general equity market. We compare ourselves against the broad equity market, and we don’t benchmark ourselves to infrastructure indices. The characteristics of the listed space are such that shareholdings tend to generate a higher dividend yield than the broader market. And because these businesses generate stable and growing cashflows often backed by inflation-protected and contractual revenues, they tend to be less volatile than the overall market over time. We measure ourselves on a five-year investment horizon against our objectives of outperforming global equities and growing the income stream for our unit holders. The fund is complementary to the income team’s existing suite of global and regional strategies, and we are privileged to be able to share in the established infrastructure expertise that exists across M&G and the broader Prudential group.

What is the sector outlook for 2017 and beyond, are the fundamentals still strong?

Why pursue a listed infrastructure strategy?

When we look across our portfolio, we see a pipeline of multi-year and in some cases multi-decade opportunities. Whether it’s the structural growth of infrastructure supporting our increasingly digital world, or requirements for more robust physical infrastructure, this is very much a long-term evolving story and it marries well with our long-term investment horizon. We feel like we’re positioned on behalf of our unit holders to benefit from an exciting future for this infrastructure asset class.

Liquidity is obviously an important feature in the listed space and we have a deep universe of investible opportunities. It stands at about $3 trillion of market capitalisation, and having that liquidity allows us to go to companies, sectors and regions where the opportunities arise. We can do that in response to the changing market conditions, changing regulatory environments, or quite simply opportunities that arise from time to time. Infrastructure indices in and of themselves tend to have some quite disproportionate and unusual underlying sector exposure. Most of them are very heavily weighted to utilities, for example. If not utilities it’s to other sub-sectors and we seek to be much more diversified by sector and certainly by region. So having an active strategy is important. In terms of the best valuations, we are bottom-up stock selectors so the individual company valuation is always the first step. That said, we obviously monitor very high level valuation trends by industry, by sub-industry, by infrastructure class and then by region. And I’d say that, currently, higher quality regulated businesses such as within utilities and energy infrastructure, particularly owing to recent nervousness around the oil price, demonstrate very interesting opportunities for us.

What is your level of exposure to certain industry sectors and regions – and why?

We split infrastructure into three classes. The first is economic infrastructure. This is the more traditional definition of infrastructure and we rely on this in our day-to-day life: utility businesses, energy infrastructure, transportation infrastructure. Within that bracket we have electricity, natural gas, water, pipelines, roads, railways and airports. This category represents between two-thirds and three-quarters of our investment in the fund. The second category is social infrastructure. This would be sectors more attuned to health and education such as hospitals, schools, universities. This is a core area for us because it offers stability and is oriented to longer-term contracts that tend to be inflation-protected. Social infrastructure is between 10% - 20% of our exposure. The third category is an exciting area for us. We call it the evolving infrastructure class. This mainly consists of businesses in the communications segment, very much attuned to the increasingly digital world we live in. In this bracket we have mobile phone towers, data centres and optical networks. We get a lot of structural growth from this element of infrastructure and it’s incredibly important for the diversification of the portfolio. It represents 15 – 25% of our exposure.

What is your investment process?

We’ve spent the last couple of years building an investible universe. It stands at about 250 companies that we’re happy to own at the right price. We built that investment universe using very strict criteria. We consider infrastructure as critical physical assets, long-life concessions and perpetual royalties. We also apply a standard that’s well founded in our income franchise philosophy which is that growth in dividends, and ultimately growing distributions to our unit holders, is the ultimate goal. We’re less focused on the absolute level of yield, even though it stands at a premium to the equity market generally. The key aspect of this and the key differentiation point for us is growth in the progressively growing income stream.

FUND Q&A

"Valuation is key to what we do. ESG considerations are integrated into the investment process and diversification across sectors and regions is extremely important to us"

Alex Araujo joined M&G’s Income team in July 2015 and was named co-deputy fund manager of the M&G Global Dividend Fund in April 2016. He has more than 20 years’ experience in financial markets, having previously worked at UBS and BMO Financial Group. Alex was appointed manager of the M&G Global Listed Infrastructure Fund at its launch in October 2017. He graduated from the University of Toronto with an MA in economics and is a CFA charterholder.

Alex Araujo, Fund manager

Find out more at www.mandg.co.uk/infrastructure

For more information contact wmfsmarketing@incisivemedia.com

Important information The fund invests mainly in company shares and is therefore likely to experience larger price fluctuations than funds that invest in bonds and/or cash. The value of investments will fluctuate, which will cause fund prices to fall as well as rise and investors may not get back the original amount invested. For financial advisers only. Not for onward distribution. No other persons should rely on any information contained within. Source of information unless otherwise: M&G statistics as at 05.10.17. This Financial Promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Conduct Authority in the UK and provides ISAs and other investment products. The company’s registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England No. 90776.