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After a period of exceptional returns, investors are likely to face a more challenging market environment in 2022, with a slowing recovery, high inflation and the potential for further COVID setbacks and geopolitical flare-ups. As well as navigating this uncertainty, markets will have to adjust to a less supportive monetary policy backdrop as central banks have started the perilous journey towards normalisation.
Given the risk of a bumpy road ahead, we expect a greater focus among investors on incorporating more-defensive features into their portfolios. In many cases, this may also involve diversifying away from a potential over-reliance on a handful of high-growth technology stocks. What constitutes effective risk mitigation will differ from portfolio to portfolio, but we think selective exposure to listed infrastructure assets may be an interesting avenue to explore when building a more defensive portfolio.
The global listed infrastructure universe contains an attractive selection of companies that, in our view, are well positioned to deliver more enduring growth, because they own long-lived physical assets that are critical to the functioning of modern economies. As a result, they may often yield-stable, long-duration income streams. They can also provide diversification potential for portfolios that have perhaps become too skewed towards technology-related growth stocks. Many of these “enduring” businesses have been around for decades and possess strong competitive positions and pricing power, often at least partly linked to inflation via regulation or contract. Frequently, these defensive characteristics are combined with exposure to secular trends such as the energy transition or the data revolution, supporting these companies’ long-term growth prospects. While history is not a guide to future performance, these more enduring assets have shown a degree of resilience to excess volatility. To date, valuations for these enduring assets are also relatively low compared with the wider market, suggesting they may be somewhat less exposed than the broader universe in the event of future volatility.
An experienced active manager, in our view, may be well positioned to aim for a further layer of mitigation by avoiding stocks that may be over-levered or too focused on divident payouts, particularly in light of rising interest rates. Investors also need to be mindful of hidden exposures that can influence the volatility profile of listed infrastructure companies. For instance, some listed infrastructure companies are inherently linked to certain commodities or are more sensitive to the economic cycle.
Finally, with the transition to low carbon now gathering momentum, we think gauging the defensive nature of a stock also involves having an accurate picture of a company’s ability and willingness to prepare for a net-zero future. As discussed in a previous article, many of the companies that own these enduring assets are well positioned to take advantage of the energy transition. But even some of the companies that, on the face of it, appear laggards in preparing for a net-zero future may well turn out to be able to progress much faster than anticipated by the market over the medium term. Again, an active manager with insights gained through deep fundamental research of the company and sector may be better placed to make that assessment and take a forward-looking view, particularly when this research is combined with robust engagement with the board and management.
Listed infrastructure assets can help diversify portfolios that may have become overexposed to technology-oriented growth stocks. Companies with enduring assets in particular display high levels of stability combined with recurring income streams and robust long-term growth prospects, so they could potentially provide some drawdown mitigation in volatile market conditions. Care needs to be taken, however, to minimise exposure to the more vulnerable stocks in the listed infrastructure universe. Provided the above caveats are met, we believe a targeted exposure to listed infrastucture companies with enduring assets could be a valuable building block for a more defensive portfolio.
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