July 2017
Which Beta is Better ?
Max Cappetta, CEO, Redpoint Investment Management
The importance of diversification for capturing the essence of infrastructure.
Infrastructure investing is increasingly popular within retirement savings plans and it is easy to understand why. The economic drivers of infrastructure firms establish an asset class which promises lower volatility and higher dividend yield than global equities, and a diversifying addition to a multi-asset class portfolio. These benefits are natural outcomes of investing in a globally diversified portfolio of companies who manage core infrastructure assets and deliver essential services. Across the global economy these companies range from water and electrical utilities, transportation companies and those that operate pipelines, telephony and satellite networks.
Investors in listed companies may be concerned that listed infrastructure companies can fall in price right along with any other listed share in moments of market stress. Technically speaking this occurs when your portfolio has a beta of 1 to global equities. Ensuring that portfolios of companies that provide core infrastructure services deliver more defensive characteristics (beta below 1) is as much about picking the right companies as it is about ensuring that investors maintain a diversified mix of different infrastructure activities.
From an analysis of the ‘collective wisdom’ of active managers and index vendors one can identify a six-way breakdown of the asset class that explains most of the risk (and return) differences between the various indexes and managers. The six subgroups draw from a wide opportunity set and include stocks from non-traditional subsectors. The key element is that the stocks should derive a significant majority of their revenues from core infrastructure activities.
Infrastructure investing is increasingly popular within retirement savings plans and it is easy to understand why. The economic drivers of infrastructure firms establish an asset class which promises lower volatility and higher dividend yield than global equities, and a diversifying addition to a multi-asset class portfolio. These benefits are natural outcomes of investing in a globally diversified portfolio of companies who manage core infrastructure assets and deliver essential services. Across the global economy these companies range from water and electrical utilities, transportation companies and those that operate pipelines, telephony and satellite networks.
Investors in listed companies may be concerned that listed infrastructure companies can fall in price right along with any other listed share in moments of market stress. Technically speaking this occurs when your portfolio has a beta of 1 to global equities. Ensuring that portfolios of companies that provide core infrastructure services deliver more defensive characteristics (beta below 1) is as much about picking the right companies as it is about ensuring that investors maintain a diversified mix of different infrastructure activities.
From an analysis of the ‘collective wisdom’ of active managers and index vendors one can identify a six-way breakdown of the asset class that explains most of the risk (and return) differences between the various indexes and managers. The six subgroups draw from a wide opportunity set and include stocks from non-traditional subsectors. The key element is that the stocks should derive a significant majority of their revenues from core infrastructure activities.
Interestingly, each of these sub-groups of core infrastructure activities carry their own risk characteristics. While each sub-group has a lower beta that listed global equities in general they also exhibit different risk characteristics relative to each other. Differing effective exposure to the six subgroups is the dominant driver of the global equity beta and total volatility outcomes of most infrastructure strategies.
From the chart above It is immediately apparent that the utilities versus non-utilities allocation is the primary driver of global equity beta in diversified portfolios. Utilities carry the lowest beta to global listed equities – exposure to these companies provides a great deal of the defensive characteristics for an infrastructure strategy.
Another dimension to the risk map is the correlation between subgroup returns:
Another dimension to the risk map is the correlation between subgroup returns:
These results highlight the diversification benefits available through holding a portfolio of properly diversified infrastructure securities. We can also clearly see which sectors deliver lower volatility and this is often rewarded with lower draw downs in periods of market stress.
Capturing the essence of the asset class
Ensuring that infrastructure portfolios are properly diversified at a sub-group level is just part of the story. Investors also need to ensure that they diversify their portfolios geographically. In Australia, while companies such as toll road operator Transurban and energy provider AGL Energy may be well run companies it makes sense to consider other similar companies in other countries that may be better investments. Furthermore, investors can access companies operating in other sectors not represented on the ASX, such as satellite and water utilities.
Another key issue is that index strategies and typical active strategies deliver relatively concentrated portfolios. Popular global infrastructure benchmarks appear diversified, with 75, 100 and more than 150 constituents, depending on the index vendor. However, market-cap weighting results in fewer than 20 stocks accounting for more than half of the index weight in each case. Typical active strategies are concentrated by design, with most active managers holding far fewer stocks than any of the indexes. Consequently, both index and typical active strategies place a significant bet on the performance of just a few firms.
The outcomes promised by investing in infrastructure are certainly attractive. Delivering on such promises is not necessarily straight forward. Investors need to be mindful that they have a well-diversified exposure to a range of core infrastructure activities – recognising their different risk profiles. This naturally leads to having a global perspective to find sufficient opportunities across the utilities, transport and networks groups.
Companies delivering core infrastructure services across the world are set to continue to grow as a key investment for retirement savings. Having a global perspective – diversified across a range of different sub-groups – is a key step to assist investors capture the essence of this asset class.
Capturing the essence of the asset class
Ensuring that infrastructure portfolios are properly diversified at a sub-group level is just part of the story. Investors also need to ensure that they diversify their portfolios geographically. In Australia, while companies such as toll road operator Transurban and energy provider AGL Energy may be well run companies it makes sense to consider other similar companies in other countries that may be better investments. Furthermore, investors can access companies operating in other sectors not represented on the ASX, such as satellite and water utilities.
Another key issue is that index strategies and typical active strategies deliver relatively concentrated portfolios. Popular global infrastructure benchmarks appear diversified, with 75, 100 and more than 150 constituents, depending on the index vendor. However, market-cap weighting results in fewer than 20 stocks accounting for more than half of the index weight in each case. Typical active strategies are concentrated by design, with most active managers holding far fewer stocks than any of the indexes. Consequently, both index and typical active strategies place a significant bet on the performance of just a few firms.
The outcomes promised by investing in infrastructure are certainly attractive. Delivering on such promises is not necessarily straight forward. Investors need to be mindful that they have a well-diversified exposure to a range of core infrastructure activities – recognising their different risk profiles. This naturally leads to having a global perspective to find sufficient opportunities across the utilities, transport and networks groups.
Companies delivering core infrastructure services across the world are set to continue to grow as a key investment for retirement savings. Having a global perspective – diversified across a range of different sub-groups – is a key step to assist investors capture the essence of this asset class.
Important information : This communication is provided by Redpoint Investment Management Pty Limited (ABN 83 152 313 758, AFSL 411671) (Redpoint). The information in the communication is of a general nature only and is not financial product advice. The communication is not intended to offer products or services provided by Redpoint or its affiliates. Opinions constitute our judgement at the time of issue and are subject to change. Neither Redpoint nor its employees or directors give any warranty of accuracy or reliability, nor accept any responsibility for errors or omissions in this communication.