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4D podcast: The growth thematics immune to economic volatility

Global Portfolio Manager and CEO, Sarah Shaw, speaks with Bennelong Account Director, David Whitby, about the long-term growth opportunities for infrastructure despite the current economic and geopolitical environment.  


“The growth opportunity is still largely underappreciated. We see five key growth dynamics within the infrastructure space that are … completely immune to the short-term economic events. So while we do have a great deal of volatility in the market at the moment, and a great deal of geopolitical and economic uncertainty, these growth thematics underpin the infrastructure investment case and are going nowhere, regardless of what happens in the short term."

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  • 0:43 – Infrastructure’s growth opportunities beyond the short-term volatility
  • 3:45 – How technology and AI are shaping the infrastructure sector 
  • 7:00 – 4D’s approach to dealing with policy and regulation 
  • 9:37 – Capturing and mitigating investment risk in the current economic landscape

The content contained in this audio represents the opinions of the speakers. The speakers may hold either long or short positions in securities of various companies discussed in the audio. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the speakers to express their personal views on investing and for the entertainment of the listener.


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David Whitby:

Hello and welcome to the latest 4D podcast. My name is Dave Whitby from Bennelong Funds Management, and joining me from 4D is the Chief Investment Officer and Global Portfolio Manager, Sarah Shaw. Sarah, thank you for your time today.

Sarah Shaw:

Thanks for having me.

David Whitby:

Sarah, there's a lot going on in markets at the moment. It's pretty choppy out there both globally and locally, but if we look through some of this short-term volatility, there are also some more exciting long-term opportunities within infrastructure.

Sarah Shaw:

Thanks, Dave. Infrastructure offers a unique combination of defensive characteristics and earnings resilience, but with significant long-term growth thematics as well as an ability to capture the current economic cycles or cyclical events. A lot of investors are aware of the defensiveness of the asset class, but I think the growth opportunity is still largely underappreciated. We see five key and integrated growth dynamics within the infrastructure space that are long-term, significant and completely immune to the short-term economic events. So while we do have a great deal of volatility in the market at the moment and a great deal of geopolitical uncertainty, economic uncertainty, these growth thematics underpin the infrastructure investment case and are going nowhere, regardless of what happens in the short term.

What are they?

So we have developed market replacement spend. So our infrastructure here is old, it's inefficient. And a failure to upgrade it could have significant social and economic consequences at a health, a safety, and an efficiency level.

Secondly, we have global population growth, but with very different dynamics or demographics across the world. The West is getting older, but much of the East younger, and both dynamics require significant investment in infrastructure.

Thirdly, we have the emergence of the middle class in developing economies, which offers a huge opportunity – with infrastructure both a driver and a first beneficiary of improved living standards. If you keep in mind that over 85% of the global population lives in the emerging world, you can understand the importance of the middle class and its evolving dynamics to the infrastructure investment case.

The fourth one is really very well understood today, and that is the energy transition that is currently underway. Now, while the speed of ultimate decarbonisation remains very unclear, there does appear to be a real opportunity for multi-decade investment in infrastructure as every country moves towards a cleaner environment.

And the fifth big growth thematic and one that is evolving very quickly is that of the rise of technology and all the associated nuance of its use and impact on infrastructure needs.

When you combine these factors – being the defensive characteristics that were previously mentioned as well as the ability to actively position and underpin by these very strong growth dynamics – the investment case for infrastructure going forward remains incredibly attractive, and we can think of no more compelling or enduring global investment thematic for the next 50 years.

David Whitby:

Thanks for that, Sarah. And I just wanted to explore one of those factors you've mentioned there, technology, which has been a big driver on all types of equity markets throughout this year. What are you really seeing with technology? How is that shaping the infrastructure sector and what role has it got to play?

Sarah Shaw:

You're exactly right. We're hearing so much about the rise of technology, about artificial intelligence and how it is the new future. But that's not going to happen or is going nowhere without the foundation infrastructure investment in place to support it. Mobile connectivity alone has emerged as a very important essential service for daily life and economic growth. Just to give you some stats, by the end of 2022, nearly 5.5 billion people globally subscribed to a mobile service. And if you can keep in mind that the global population is just over 7 billion, we've got a large percentage of the global population actually subscribing to mobile services. We've got mobile technologies and services generating roughly 5% of GDP, which is creating over $5 trillion of economic value. So you can see the importance of just mobile technology alone.

5G itself has seen significant investment over the past few years, driven by the need for higher speeds in improving technology. In particular, the explosive growth in what is called the Internet of Things has been a key driver of 5G rollout given the requirements for rapid speeds and very low latency. The Internet of Things describes physical objects with sensors that communicate with computing systems via the wired or the wireless networks. So this explosive growth in both data consumption and the Internet of Things is fueling significant investment opportunities for digital infrastructure owners globally. For us, this means cellular towers, which will play a key role in building out wireless networks as they house the electronic communications equipment, and antennae, which provide surrounding areas the ability to communicate wirelessly.

With a continuous evolution of technology and its expanding significance in our everyday lives, the role of dependable and high-speed wireless networks becomes increasingly important for the fostering of growth of both the daily usage as well as the global economy. However, as infrastructure investors, we also benefit through the growing importance of technology in enhancing the efficiency and therefore the profitability of all operations, whether they be transport or energy. For example, we take a port operator. The technological innovation will push forward increasing automated and smart ports projects, which will enable port operators to further improve efficiency for the entire logistics chain and cost control to enhance profitability. This is a phenomena being adopted across the entire infrastructure space. We've got automatic tolling, smart metering, driverless vehicles. So not only is infrastructure driving the technology boom, but providing the foundation infrastructure is also a key beneficiary of that technology boom through increased efficiency and profitability.

David Whitby:

Excellent. So some interesting thematics there, Sarah. How do you capitalise on some of these longer-term ones and how can they be impacted by increased regulation and government policies?

Sarah Shaw:

You're right, Dave. These are very long-dated thematics. And as such, infrastructure assets are very long-dated projects, and they generally have a high upfront capital cost and then what we call lower ongoing maintenance cost and scale advantages. But given that upfront nature of the investment obligation, the regulation and all the contracts underpinning our future returns are critical for us to make an investment decision. So the strength of regulatory models or contract structures are a key to our stock analysis and our investment decisions, and we therefore do sensitivity analysis around shifts within those as well.

However, even before we start looking at stocks, as part of our country risk assessment the governance of a country and the strength of its judicial system should be considered closely as it goes to the quality and the reliability of infrastructure concession contracts or regulation, and how strong the judicial system is in supporting the sanctity of those contracts or regulation. Similarly, levels of corruption are important, together with how well the judiciary is tackling that issue. For example, in Brazil the so-called carwash corruption investigation has been ongoing and far-reaching, but it is activities such as this that helps investors become more comfortable with the sovereign and the judicial system upholding the contracts that they're investing in.

So we're not denying there is a degree of corruption, but the judiciary has been very persistent and diligent in its pursuit of wrongdoing at all levels of society. If we as a business cannot get comfortable with the independence and strength of a judicial system, then it is very difficult to get comfortable with regulatory frameworks or contracts supporting infrastructure decisions that are very long-dated. Governments are going to come and go. And when valuing cash flows over 20, 30, 40 years, we need to really rely on the regulatory model or contract, which is a key characteristic of infrastructure ownership, long-term visible and resilient earning streams underpinned by contract or regulation. So for us it is understanding the country, understanding the strength of its judicial system, and then digging very deeply into the strength of the contract or regulation that is underpinning our investment returns.

David Whitby:

We've really tackled there some of the longer-term growth thematics that underpin the infrastructure growth story, but then thinking about some of the shorter-term opportunities or risks, how are you looking to either capture or mitigate some of those?

Sarah Shaw:

There's plenty of them around today and it would be very easy to have a negative outlook in the current volatile economic landscape. We have sticky inflation, we have higher interest rates and costs, we have declining savings rates and we have significantly increasing geopolitical concerns. And listed infrastructure of course is an equity and can be caught up in market volatility like all other listed securities. However, we must look to separate the equity market moves from the investment fundamentals and the structural characteristics and growth drivers that underpin the infrastructure investment case. If these remain intact, then we can look through some of this short-term noise to be guaranteed stronger longer-term returns.

For us at 4D, we believe that the combination of the defensive investment characteristics that are pretty well understood coupled with that huge and growing need for infrastructure investment to underpin those thematics discussed, as well as the diverse nature of the assets within the universe, means that if you actively manage an infrastructure portfolio, you can position it for those long-term structural thematics, but as well as all the short-term cyclical events that the world is throwing at us, whether they're economic, political, or environmental.

At the moment, we see some key fundamental opportunities in being overweight inflation. Inflation remains sticky in many parts of the world and we are capitalising on those opportunities that have an explicit inflation passthrough, which for us means we're favouring the user pay assets as well as real rate utilities.

The second big opportunity for us at the moment is the travel space. Despite a huge amount of talk around affordability in the current environment, during our most recent trip to Europe in July we saw large numbers of people travelling, eating out and spending money on experiences. They were definitely prioritising these forms of activities over other forms of discretionary spending. And this was interestingly without the return of the Chinese tourist, which is only starting to come back. So this ongoing demand for travel supports again our overweight to the infrastructure supporting it, namely user pay assets such as airports.

But not to ignore the risks. So some of our concerns at the moment, we are looking at a ‘higher for longer’ interest rate environment. This does put pressure on economies as well as on those assets without a passthrough of inflation and interest rates such as nominal rate utilities, which are feeling an earnings pinch. This is also impacting some investment pipelines in certain sectors and parts of the world due to the squeeze on return profiles. Focused in the media has been the renewable space.

The second concern is clearly China's lacklustre reopening. The COVID reopening boom and revenge spending that was witnessed globally did not eventuate or persist as expected in China. Whilst activity data, credit growth, and consumer and business confidence has been weak, there have been some signs of stabilisation in recent data points, albeit is still very early days. We continue to be highly selective in the 4D portfolio and continue to invest on fundamental value and assess investment opportunities that are beneficiaries to the Chinese economy, both directly and indirectly, and we still do have exposure to China.

The third concern is increasing climate risk. The increasing incidence of events such as storms, floods, droughts and wildfires have significant political economic and social consequences. 4D believes that these threats are real. We can no longer ignore them, and they should be incorporated into the assessment of the risks and opportunities offered by the infrastructure asset class.

And the fourth big risk at the moment is clearly geopolitical activity. The ongoing situation in Ukraine and recent activity in Israel-Palestine are socially devastating, and will also pressure markets as investors seek safety. There is no direct impact on our names, albeit we do see indirect impacts through economic drivers such as higher oil prices. So 4D are remaining very conscious of the economic environment and the political overhangs, and continue to position to make the most of the in-country cyclicals, as well as those long-term investment thematic that we discussed earlier.

David Whitby:

Great. Sarah, thank you very much for that. That was pretty comprehensive there. Thanks very much for listening.

Sarah Shaw:

Thank you.