Because even “safe” stocks are risky: 7 steps to help spot red flags

Investing involves risk. This is true for whatever assets you’re buying, whether they're the latest “meme stocks”, government bonds, or equities in defensive sectors such as listed infrastructure. This point was emphasised by 4D Infrastructure’s CIO and portfolio manager, Sarah Shaw, during a recent interview.

Shaw listed four categories of risk for listed infrastructure assets:

• Greenfield risk
• Regulatory risk
• Political risk
• Sovereign risk.

“We’re talking about equities, and these assets will move with equity markets,” Shaw said.
“That’s a risk but it’s also a huge opportunity. When markets overreact or are inefficient and you have a strong view on fundamental value, you can add alpha (above benchmark returns) over the long term.”

Before specific companies are added to the 4D Global Infrastructure portfolio, they must clear several hurdles related to industry structure and competitive landscape, balance sheets, management performance and other factors. These are detailed in the following interview, where Shaw also explains why her team gives equal consideration to individual companies’ environmental, social and governance scorecards, without favouring one element over another.

Edited transcript

Is there any infrastructure you stay away from?

Sarah Shaw: It comes down to that definition. If an infrastructure stock meets that definition, if it provides the characteristics that we are looking for in infrastructure, it will make it into our core investible universe.

If it doesn't provide those characteristics, it doesn't even make it into the investible universe. So we don't avoid parts of that core investible universe. But we actively position based on where we feel we are in the economic cycle, which determines whether we are overweight those macro sensitive stocks, such as the user pays assets, or overweight the regulated utilities or those very defensive earnings-immune stocks when they need it. So we don't avoid stocks, but we will be overweight one or other of those sub-sectors as we believe the market dictates.

What is the risk spectrum in infrastructure? Is the term "high-risk infrastructure investment" an oxymoron or does that risk exist in the sector?

Shaw: Great question. What is risk? There's definitely risk; there's a risk to every asset. 

There's a greenfield risk if you're building out an asset.

There's regulatory risk, depending on the regulatory environment.

There's political risk, there's sovereign risk.

These are all risks that we assess both at a country level before we even make an entrance or look at stocks within a country. So we assess countries based on financial risk, economic risk, political risk and ESG or sustainability risk.

Once we get to the stocks, we're looking at a real combination of quality and value. The risks are factored into that value. They're factored into that quality. We look at things like the industry structure, the competitive nature, the regulatory environment, the balance sheets, management performance, their own performance on sustainability or responsible investment strategies.

So, there's risk in every investment, I guess the big risk to listed infrastructure is that it is an equity and as such, it will move with equity markets. That is a risk, but also it's a huge opportunity as we've discussed. When the markets overreact or are inefficient, if you really have a view on fundamental value, you can use that opportunity to add alpha over the longer term.

How do you factor ESG into your filtering process and conversely, how do companies factor ESG into the way they manage their infrastructure assets?

Shaw: ESG is that continuously evolving topic. It's the one topic that's moving very, very rapidly in all forms of investing. Now, ESG has always been part of our process. It's a part of our screening process into getting stocks into the core investible universe. It's part of our country review process. It's part of our company quality assessment. And it's also part of that portfolio construction.

For us, ESG is incredibly important. We probably prefer sustainable or responsible investing, but ESG is part of that. What I would say though is at 4D, we believe that E the S and the G are equally important. Environmental gets a great deal of focus and it is important, but you can't be environmentally cognisant without being socially responsible and having proper corporate governance. That doesn't make you sustainable.

A great example could be a pure-play renewable company that's building out without thinking of social aspects, or not thinking of shareholder returns – that's not sustainable. By contrast, you could be the best run coal-fired generation plant in the world, but you're also not sustainable. So we are really for that strong combination of E the S and G to see a really sustainable company or country. And that's where we're sort of really focusing our efforts.

Invest across the globe

4D, a Bennelong Funds Management boutique, invests in listed infrastructure companies across all four corners of the globe. For more insights on global infrastructure, click the 'FOLLOW' button or visit 4D’s website.