How to invest in the next big growth theme (but with more stability)

After the stellar year for the Magnificent Seven, many investors are on the hunt for the next big theme – or at least, the next phase of the AI-boom. But while the equities space is looking expensive at the top end and the lower echelons are scattered with both unicorns and flash-in-the-pan picks, there is another option for savvy investors.

Better yet, pending on your approach, you can largely ignore the peaks and troughs of the economic cycle – potentially a huge win given we face an easing cycle and tougher consumer environment.

This unique option? Global listed infrastructure.

While the sector may slip under the radar, Resolution Capital’s Sarah Lau points out that all the major global themes: digitisation, decarbonisation, and mobility, require infrastructure to support them. Some existing high-quality options already offer consistent and stable growth and income, which is only set to lift further on the back of growing demand from the major global themes.

Take Dominion Energy (NYSE: D) for example. Lau notes that it is an existing electricity utility with a monopoly. The AI trend is power-hungry and electricity providers will benefit from increasing demand.

In this episode of The Pitch, Lau discusses what the global listed infrastructure space looks like, key drivers and how to evaluate investments in this space. She also shares three key holdings in the Resolution Capital Global Listed Infrastructure Fund portfolio.

Edited transcript

What is the size of the global listed infrastructure space and what types of assets sit in the space?

The global listed infrastructure space is a very large and liquid opportunity set, roughly US$3 trillion in market cap. It’s mostly in developed markets. These companies are underpinned by real assets and we’re looking at utilities such as those in water, gas and electricity. We look at transport infrastructure like railroads, toll roads, airports and ports, and we’re also looking at telecommunications infrastructure, that’s mobile network towers and fibre.

All of these assets are critical to the economy. 

They provide essential services and have very strong pricing power. What this means over the long term is they have cash flows that are not really impacted by the economic cycle, but they do benefit from long-term growth trends.

How has the global listed infrastructure space been affected by inflation and rising interest rates? Are certain segments better suited to manage the conditions?

The global listed infrastructure sector was impacted by changing interest rate settings. When interest rates bottomed, it was in August 2020 at about 0.5% for US Treasuries to almost 5% for US 10-year Treasuries by October 2023. During that period, the sector generated 2% positive total returns, but it significantly underperformed general equities which generated 6.5% in that same period of time.

When we look at valuations over that time, the impact is quite limited because these assets in aggregate tend to pass on inflation using mechanisms such as contracts – they have contractual increases every single year through regulation. Or, sometimes it’s more indirect and because they have such strong pricing power, they are able to pass through these inflation impacts to customers.

What this means for us is that when we saw inflation pressures, we tilted the portfolio towards sectors which had faster and more pass-through, like UK utilities and toll roads.

Now that we see inflation seems to have peaked, we have selectively positioned in sectors such as mobile network towers which don’t actually have very much inflation pass-through, but we feel that valuations are now reflecting the current higher interest rate environment.

Over the long term, there’s been very good inflation pass-through in the portfolio. About 87% of the portfolio is hedged to inflation and really benefits over the long term from economic growth drivers.

What are some of the key themes and drivers that you are watching for the portfolio?

For our portfolio, the key themes are decarbonisation, digitisation and mobility. These trends are really driven by the changing needs of society, and there’s significant investment needed to cater for this. There’s a huge role for private capital because the needs are so huge and government balance sheets are really stretched.

We think, because of how big these needs are, the returns generated should be quite reasonable. There’s a hug push towards decarbonisation and it’s driven not just by policy, but also from economics. In a lot of places globally, the cheapest form of electricity generation is actually solar and onshore wind. This means there is a lot of investment upfront to build these things, but then when they operate, it’s almost free.

We have stock such as Dominion Energy, which is an electricity utility that benefits from these investments. Another trend to benefit Dominion Energy is digitisation. The way it benefits is from the need for more power. It’s driven by the AI datacentre hungriness in terms of electricity consumption.

Digitisation also benefits communications infrastructure – we see mobile network towers and fibre assets benefit from this.

The last trend we’re watching in the portfolio is mobility. That’s the movement of people and things. We have a portfolio holding, Ferrovial (BME: FER), that really benefits from that, it’s a really long dated trend. It’s driven by population growth, urbanisation and changes in the supply chain with more recent near-shoring that is going to drive these assets over the long run. What we’re seeing across the portfolio and across this space are really long-term economically resilient drivers that will benefit these stocks and companies over multiple decades.

What process do you use to identify infrastructure investments for the portfolio?

We’re trying to invest in core infrastructure. What I mean by that is hard assets which are monopolistic. 

We really like that they have extremely strong barriers to entry, it gives them very strong pricing power. They provide services which are critical to the economy so you don’t get that cyclicality in cashflows when the economy moves up and down.

Then the third thing we like about them is they benefit from those megatrends which I outlined earlier and there’s some others we try to get that from. We tend to look for valuations and cashflows and earnings, rather than revenues. We do have a benchmark, that’s the FTSE Developed Core Infrastructure 50/50 Index. But, that doesn’t dictate what we invest in and what we consider investible, because benchmarks tend to focus on revenues and we find that doesn’t really match what we want to achieve for our investors.

We can invest up to 30% of the portfolio outside of the benchmark. In terms of valuation, we have a very disciplined framework. We’re really focused on an underlying bottom-up bias, the cashflows and risks of the assets that these companies own. We look at multiple valuation metrics, such as portfolio multiples and also discounted cash flows. One metric which we do like better than the others is internal rates of return, which is our forecast on average of the total return over the next five years. Ultimately, what we’re trying to do is identify the underlying assets that benefit the most from these themes and we’re not really just investing in the themes.

You mentioned Dominion Energy earlier. Can you share another example of an investment that you've got in the portfolio and why you chose it?

We like stocks that have quality assets. The ones that benefit in an outsized way in capturing some of the trends that we talked about. We like strong balance sheets and solid management with skin in the game. One name we like is National Grid (NYSE: NGG), post a recent equity raising. They’ve done well to generate between 6-8% EPS growth and we think they can do a little bit better than that. They also have a dividend yield of just over 5%. National Grid is an UK electric utility. It owns poles and wires and we think the growth here is accelerating because the UK government is keen to accelerate decarbonisation. They want to accelerate and decarbonise the entire electricity sector by 2030. That’s a huge task. It requires a lot of investment and National Grid is a very low risk way of capturing that.

Another name we like is Union Pacific (NYSE: UNP), that’s a US railroad business.

We think the medium-term movement of freight within the US is underappreciated because there is a lot of investment in nearshoring. A lot of these are still being deployed, but over the medium term, the freight movements within the US and particularly between US and Mexico is underappreciated. We think it is well positioned to accelerate EPS growth into the double digits. We’re trying to capture the most upside in identifying these names and stocks that we like over the next three to five years, with the least amount of risk possible.

Access to income and growth over the long-term

Sarah and the team are focused on companies which own physical assets or concessions which provide essential services. These assets typically have high barriers to entry, require significant capital investment as well as generate long dated and predictable cashflows. To learn more, visit the Resolution Capital website, or the fund profile below.

Managed Fund

Resolution Capital Global Listed Infrastructure Fund

Global Shares

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