Welcome to the Fear And Greed Daily Interview. I'm Sean Aylmer. We talk a lot about big deals involving infrastructure assets from airports and toll roads to electricity grids and water projects. There's been something of a deal frenzy of late with big investors led by the super funds, looking for quality assets that can deliver reliable returns over longer periods. Today, I wanted to find out what makes infrastructure assets and operators appealing to investors and where the opportunities might lie, both here and overseas. Sarah Shaw is the Global Portfolio Manager and Chief Investment Officer of 4D Infrastructure, an asset manager, investing in listed infrastructure companies, right around the world. 4D is part of the broader Bennelong Funds Management Group. Sarah, welcome to Fear and Greed.

Welcome to the Fear And Greed Daily Interview. I'm Sean Aylmer. We talk a lot about big deals involving infrastructure assets from airports and toll roads to electricity grids and water projects. There's been something of a deal frenzy of late with big investors led by the super funds, looking for quality assets that can deliver reliable returns over longer periods. Today, I wanted to find out what makes infrastructure assets and operators appealing to investors and where the opportunities might lie, both here and overseas. Sarah Shaw is the Global Portfolio Manager and Chief Investment Officer of 4D Infrastructure, an asset manager, investing in listed infrastructure companies, right around the world. 4D is part of the broader Bennelong Funds Management Group. Sarah, welcome to Fear and Greed.

Many thanks for having me.

Many thanks for having me.

So, why invest in infrastructure? Tell me the benefits of it.

So, why invest in infrastructure? Tell me the benefits of it.

Yeah, look, infrastructure is known as a defensive asset class and as an infrastructure investor, I love the characteristics that provide that defensiveness. And by that, I mean it has monopolistic market positions or ones with high barriers to entry, it has earnings that are underpinned by contract or regulation, it's a very long dated asset which has high upfront capital costs and then very low maintenance spend, and there's inflation hedges within the business model. All these characteristics come together to give you long term visible and resilient cash flows, which either underpin a yield or growth. So that's a really attractive characteristics around the asset class. But then when you couple that with the fact that there's a huge and growing need for infrastructure investment globally, as well as the diversity of assets within the infrastructure universe, then as an asset class, it can be actively positioned for all points of the market cycle and for all cyclical events that the world throws at us, whether they be economic, political, financial, whatever it may be, you can position a defensive asset class to capture the upsides and protect on the downside. And these are the points around the asset class that we find particularly attractive.

Yeah, look, infrastructure is known as a defensive asset class and as an infrastructure investor, I love the characteristics that provide that defensiveness. And by that, I mean it has monopolistic market positions or ones with high barriers to entry, it has earnings that are underpinned by contract or regulation, it's a very long dated asset which has high upfront capital costs and then very low maintenance spend, and there's inflation hedges within the business model. All these characteristics come together to give you long term visible and resilient cash flows, which either underpin a yield or growth. So that's a really attractive characteristics around the asset class. But then when you couple that with the fact that there's a huge and growing need for infrastructure investment globally, as well as the diversity of assets within the infrastructure universe, then as an asset class, it can be actively positioned for all points of the market cycle and for all cyclical events that the world throws at us, whether they be economic, political, financial, whatever it may be, you can position a defensive asset class to capture the upsides and protect on the downside. And these are the points around the asset class that we find particularly attractive.

Okay. So you talked about all different sectors and the fact that sort of what you're inferring is there's diversity within infrastructure, what are some of the sectors you invest in?

Okay. So you talked about all different sectors and the fact that sort of what you're inferring is there's diversity within infrastructure, what are some of the sectors you invest in?

Yeah, look, I'll probably just split this into two, and the way I look at it, or the way we look at it, I should say, is that despite sharing these defensive characteristics that I mentioned, there's two very and quite distinct and economically diverse sub- sectors within infrastructure. So on the one hand you have what we call " essential services," now these are your regulated utilities in the power and the water space. These assets are really largely immune to economic shifts, both up and down, as a function of them being a basic need, as well as the structure of their regulatory environment, which measures returns independent of volumes. Now these are the assets that are more bond proxy in nature, they're more immediately adversely impacted by rising inflation and interest rates, and they're slower to realise the benefits of economic growth. But at the same time, they are less exposed to economic contraction and they benefit from lower interest rates. So these are the assets that are at attractive overweight portfolio position in really depressed economic environments, as they'll offer you sort of earnings growth and yield support, even in a year like 2020. So look last year, the utility companies or the essential services around the world reported strong earnings and strong dividends.

Yeah, look, I'll probably just split this into two, and the way I look at it, or the way we look at it, I should say, is that despite sharing these defensive characteristics that I mentioned, there's two very and quite distinct and economically diverse sub- sectors within infrastructure. So on the one hand you have what we call " essential services," now these are your regulated utilities in the power and the water space. These assets are really largely immune to economic shifts, both up and down, as a function of them being a basic need, as well as the structure of their regulatory environment, which measures returns independent of volumes. Now these are the assets that are more bond proxy in nature, they're more immediately adversely impacted by rising inflation and interest rates, and they're slower to realise the benefits of economic growth. But at the same time, they are less exposed to economic contraction and they benefit from lower interest rates. So these are the assets that are at attractive overweight portfolio position in really depressed economic environments, as they'll offer you sort of earnings growth and yield support, even in a year like 2020. So look last year, the utility companies or the essential services around the world reported strong earnings and strong dividends.

I'm going to jump in there, Sarah. So, give me some examples of the regulated infrastructure asset, so is that power lines, for example? Is that the sort of thing you're talking about?

I'm going to jump in there, Sarah. So, give me some examples of the regulated infrastructure asset, so is that power lines, for example? Is that the sort of thing you're talking about?

Exactly. We're talking about your poles and wires, your transmission and your distribution networks, your water utilities. Here in Australia, it'd be the AusNets of the world, that's just been taking out. Or around the world, it'd be your big U. S. Utilities, or Europe, your big European utilities, like Iberdrola or NextEra. So these are the big essential service operators that are providing the power that we need, the clean water that we need, as a community to function.

Exactly. We're talking about your poles and wires, your transmission and your distribution networks, your water utilities. Here in Australia, it'd be the AusNets of the world, that's just been taking out. Or around the world, it'd be your big U. S. Utilities, or Europe, your big European utilities, like Iberdrola or NextEra. So these are the big essential service operators that are providing the power that we need, the clean water that we need, as a community to function.

And the reason they're regulated, for the listeners who don't follow infrastructure, it's because government has some say over how they operate and therefore they're regulated, therefore you're going to get an ongoing yield or ongoing return, no matter what happens.

And the reason they're regulated, for the listeners who don't follow infrastructure, it's because government has some say over how they operate and therefore they're regulated, therefore you're going to get an ongoing yield or ongoing return, no matter what happens.

Exactly, the regulator, because they're monopolistic. So if you didn't have a regulatory model in place, those monopolistic positions could give them the power to charge whatever they wanted for the access to what we consider to be basic goods and services. So the government or the regulator limits their earning profile, but also allows them an earning profile that facilitates increased investment in that network or in its security of supply. So it's a win- win situation. You, you know exactly what you're going to earn, based on what you invest, but you're capped, based on basic bill affordability, so that the monopolistic position doesn't allow you to over earn.

Exactly, the regulator, because they're monopolistic. So if you didn't have a regulatory model in place, those monopolistic positions could give them the power to charge whatever they wanted for the access to what we consider to be basic goods and services. So the government or the regulator limits their earning profile, but also allows them an earning profile that facilitates increased investment in that network or in its security of supply. So it's a win- win situation. You, you know exactly what you're going to earn, based on what you invest, but you're capped, based on basic bill affordability, so that the monopolistic position doesn't allow you to over earn.

Okay, so that's regulated. So, the other side?

Okay, so that's regulated. So, the other side?

Yeah, so the other side is what we call " user pay assets." Now, these are your airports, your toll roads, your ports, your rail operators. Now they have a 100% positive correlation to GDP growth and inflation. So these stocks capture GDP growth through your volumes, you know cars on roads, passengers through airports, but they have an explicit inflation protection through their tariff structures. So these are the assets that are really well suited to strong economic growth and inflationary environments, which we're sort of seeing today. So if you take today's inflationary scenario, user pay assets should enjoy the perfect storm over the short to medium term, and that's really low interest rates to support future growth, they've got economic activity flowing through to volumes, and they have an explicit inflation hedge, which will combat any inflationary uptick that we are experiencing at the moment. So for us at the moment, we're sort of sitting that overweight in the user pay category and sort of limiting our exposure to that essential services, which protects on the downside or in that weaker environment that we saw in 2020.

Yeah, so the other side is what we call " user pay assets." Now, these are your airports, your toll roads, your ports, your rail operators. Now they have a 100% positive correlation to GDP growth and inflation. So these stocks capture GDP growth through your volumes, you know cars on roads, passengers through airports, but they have an explicit inflation protection through their tariff structures. So these are the assets that are really well suited to strong economic growth and inflationary environments, which we're sort of seeing today. So if you take today's inflationary scenario, user pay assets should enjoy the perfect storm over the short to medium term, and that's really low interest rates to support future growth, they've got economic activity flowing through to volumes, and they have an explicit inflation hedge, which will combat any inflationary uptick that we are experiencing at the moment. So for us at the moment, we're sort of sitting that overweight in the user pay category and sort of limiting our exposure to that essential services, which protects on the downside or in that weaker environment that we saw in 2020.

Okay. I mean, what's interesting here is that infrastructure as an asset class is extremely diverse. So in a sense to think you are investing in infrastructure, you have to look well beyond that.

Okay. I mean, what's interesting here is that infrastructure as an asset class is extremely diverse. So in a sense to think you are investing in infrastructure, you have to look well beyond that.

Look, we sort of had that narrow definition of what infrastructure means. We really want it to provide those defensive characteristics that I discussed. So for us, it really does limit the sector exposure to those essential services and user pay assets. However, to your point, yes, it's a global theme. So we have assets all over the world, so you have that geographic diversity. So our universe of opportunity set at the moment, it sits around about 300 listed stocks globally. So we have a huge opportunity set where we can capitalise on both in- country domestic demand, we can capitalise on in- country inflation, we can capitalise on in- country stimulus programs, and really put together a portfolio of the best opportunities globally within that infrastructure universe.

Look, we sort of had that narrow definition of what infrastructure means. We really want it to provide those defensive characteristics that I discussed. So for us, it really does limit the sector exposure to those essential services and user pay assets. However, to your point, yes, it's a global theme. So we have assets all over the world, so you have that geographic diversity. So our universe of opportunity set at the moment, it sits around about 300 listed stocks globally. So we have a huge opportunity set where we can capitalise on both in- country domestic demand, we can capitalise on in- country inflation, we can capitalise on in- country stimulus programs, and really put together a portfolio of the best opportunities globally within that infrastructure universe.

Okay, so I just want to ask a couple of specifics. Now, the first was about interest rates and what happened during COVID. Now you've sort of answered that, in terms of, if you get into the regulated infrastructure world, that presumably outperformed during COVID, and now that we're coming out and economic growth is picking up, inflation is picking up, user pay assets, perhaps are more attractive. The other one I wanted to ask about was climate change and how that plays on infrastructure assets?

Okay, so I just want to ask a couple of specifics. Now, the first was about interest rates and what happened during COVID. Now you've sort of answered that, in terms of, if you get into the regulated infrastructure world, that presumably outperformed during COVID, and now that we're coming out and economic growth is picking up, inflation is picking up, user pay assets, perhaps are more attractive. The other one I wanted to ask about was climate change and how that plays on infrastructure assets?

Yeah, look, it's clearly a very big thematic. Look, within the infrastructure world, we see four very long term key thematic for infrastructure investors. One's developed market replacement spend. The second is population growth. The third is the emergence of the middle class. And those latter two are also driving or increasing the risk of the fourth thematic, which is decarbonisation goals, and that's a global goal to be net zero by 2050. That's an incredible thematic for infrastructure investors. And I just point out, we have, and no question, we have been part of the carbon problem as we've gone through a century of industrialization, infrastructure, and generation, and electricity, and transport have all contributed to the carbon emissions that we now need to stem and reverse. However, what I would also say is that without increased investment in infrastructure, there is no chance that the world will get to net zero by 2050 unless we can improve the energy or electrification and make that renewable. We've got 25% of carbon emissions globally at the moment, just from the electricity sector. Unless we can change transport to be more carbon friendly, then there's another 15% of carbon emissions that won't go anywhere. So we really need to invest heavily in infrastructure, in order to facilitate our global decarbonisation goals. It is a little bit compounded by that emergence of the middle class and the population growth, you know emerging markets are coming into their fore, they're evolving, people are getting access to power and roads and cars. So we really want them to do that in a cleaner way, at the outset, so that we aren't compounding the problem and that we're facing from the developed market, industrialization over the last century. So there's just a wealth of opportunity in renewable energy assets, there's transmission and distribution grids need to be strengthened in order to connect to that renewable energy. The security of supply of the electricity sector needs to be firmed up, and that includes things like batteries. We also have the new technologies that our government is consistently talking about such as green hydrogen or carbon capture and storage. All of that is just within the electricity sector. And then we move to the transport sector where we need to see greener roads, whether it's materials to build them or the ability to facilitate electric vehicles. We need to see both our shipping and our air transport become greener. So all of those elements are huge investment opportunities for us as infrastructure investors.

Yeah, look, it's clearly a very big thematic. Look, within the infrastructure world, we see four very long term key thematic for infrastructure investors. One's developed market replacement spend. The second is population growth. The third is the emergence of the middle class. And those latter two are also driving or increasing the risk of the fourth thematic, which is decarbonisation goals, and that's a global goal to be net zero by 2050. That's an incredible thematic for infrastructure investors. And I just point out, we have, and no question, we have been part of the carbon problem as we've gone through a century of industrialization, infrastructure, and generation, and electricity, and transport have all contributed to the carbon emissions that we now need to stem and reverse. However, what I would also say is that without increased investment in infrastructure, there is no chance that the world will get to net zero by 2050 unless we can improve the energy or electrification and make that renewable. We've got 25% of carbon emissions globally at the moment, just from the electricity sector. Unless we can change transport to be more carbon friendly, then there's another 15% of carbon emissions that won't go anywhere. So we really need to invest heavily in infrastructure, in order to facilitate our global decarbonisation goals. It is a little bit compounded by that emergence of the middle class and the population growth, you know emerging markets are coming into their fore, they're evolving, people are getting access to power and roads and cars. So we really want them to do that in a cleaner way, at the outset, so that we aren't compounding the problem and that we're facing from the developed market, industrialization over the last century. So there's just a wealth of opportunity in renewable energy assets, there's transmission and distribution grids need to be strengthened in order to connect to that renewable energy. The security of supply of the electricity sector needs to be firmed up, and that includes things like batteries. We also have the new technologies that our government is consistently talking about such as green hydrogen or carbon capture and storage. All of that is just within the electricity sector. And then we move to the transport sector where we need to see greener roads, whether it's materials to build them or the ability to facilitate electric vehicles. We need to see both our shipping and our air transport become greener. So all of those elements are huge investment opportunities for us as infrastructure investors.

Stay with me Sarah, we'll be back in a minute.

Stay with me Sarah, we'll be back in a minute.

My guest today is Sarah Shaw, Chief Investment Officer of 4D Infrastructure. Sarah, you manage two funds, the 4D Global Infrastructure Fund and the 4D Emerging Markets Infrastructure Fund.

My guest today is Sarah Shaw, Chief Investment Officer of 4D Infrastructure. Sarah, you manage two funds, the 4D Global Infrastructure Fund and the 4D Emerging Markets Infrastructure Fund.

Yes.

Yes.

How different is investing in emerging markets in terms of infrastructure?

How different is investing in emerging markets in terms of infrastructure?

To be honest, I would say that identification of the opportunities and the risk screens remain consistent between our global and emerging market strategies. You know, the definition of infrastructure is the same, the expectations of industry asset and management quality are the same. Where we see a different part to the opportunity set is really around those thematics I just mentioned. You know, the population growth that we talk about, that's largely been driven by the emerging economies. That evolving middle class is a huge theme that we think you can capitalise on via that direct investment in the emerging markets. Very simply if you take it from an individual's perspective, as your wealth starts to improve, your consumption patterns change. You know, it starts, I want three meals a day, then start with, I want basic essential services such as clean water or indoor plumbing, gas for cooking, heating, all of those things that we take for granted. And then once you get those things, you want fridges and TVs, which increases the use of that power or increases the need for ports and logistics chains. And I guess over time, you then think I want a scooter or a car, I need roads, I need airports. All of those sorts of things come together to provide a huge opportunity set in the infrastructure space in emerging markets. And that's a little bit different, but the quality of the assets and how we look at the assets, it is very, very similar to what we're seeing in the developed world.

To be honest, I would say that identification of the opportunities and the risk screens remain consistent between our global and emerging market strategies. You know, the definition of infrastructure is the same, the expectations of industry asset and management quality are the same. Where we see a different part to the opportunity set is really around those thematics I just mentioned. You know, the population growth that we talk about, that's largely been driven by the emerging economies. That evolving middle class is a huge theme that we think you can capitalise on via that direct investment in the emerging markets. Very simply if you take it from an individual's perspective, as your wealth starts to improve, your consumption patterns change. You know, it starts, I want three meals a day, then start with, I want basic essential services such as clean water or indoor plumbing, gas for cooking, heating, all of those things that we take for granted. And then once you get those things, you want fridges and TVs, which increases the use of that power or increases the need for ports and logistics chains. And I guess over time, you then think I want a scooter or a car, I need roads, I need airports. All of those sorts of things come together to provide a huge opportunity set in the infrastructure space in emerging markets. And that's a little bit different, but the quality of the assets and how we look at the assets, it is very, very similar to what we're seeing in the developed world.

But presumably more risk as well?

But presumably more risk as well?

I may be a little bit biased, but to be very clear, I think risk is not confined to emerging markets. Internally we do an assessment of risk at both a country and a company level, whether it's in a developed or an emerging market. So across both strategies, the country itself must be an acceptable investment destination before we even look at stocks in that country. And there's no question, certain emerging countries get ruled out on that basis. We don't see them as an acceptable long term investment destination. However, if you really do just focus in on the emerging markets and you mentioned some of those risks that we all associate with emerging markets, such as inflation, sovereign risk, all of those things, emerging market infrastructure hedges a number of those. So you are actually getting access to a really strong domestic demand story while hedging some of the key risks of emerging markets. And just to mention a couple of those, that's inflation. Okay, we are going to see inflationary pops in emerging markets as they evolve, you hedge it with infrastructure. Secondly, I think the big other one that many people mention is sovereign risk. Look emerging market governments and policy makers, and I'd take this for all governments and policy makers, to be honest, they have realized that they need improved infrastructure to enable their economies to evolve. As they can't facilitate all that investment, they are very supportive of private sector investment coming in to provide the infrastructure they need. Now, while they need your money, you're pretty safe that you're going to get an acceptable investment return. And I would say this for any country in the world, when the government doesn't need your investment dollar anymore, get out.

I may be a little bit biased, but to be very clear, I think risk is not confined to emerging markets. Internally we do an assessment of risk at both a country and a company level, whether it's in a developed or an emerging market. So across both strategies, the country itself must be an acceptable investment destination before we even look at stocks in that country. And there's no question, certain emerging countries get ruled out on that basis. We don't see them as an acceptable long term investment destination. However, if you really do just focus in on the emerging markets and you mentioned some of those risks that we all associate with emerging markets, such as inflation, sovereign risk, all of those things, emerging market infrastructure hedges a number of those. So you are actually getting access to a really strong domestic demand story while hedging some of the key risks of emerging markets. And just to mention a couple of those, that's inflation. Okay, we are going to see inflationary pops in emerging markets as they evolve, you hedge it with infrastructure. Secondly, I think the big other one that many people mention is sovereign risk. Look emerging market governments and policy makers, and I'd take this for all governments and policy makers, to be honest, they have realized that they need improved infrastructure to enable their economies to evolve. As they can't facilitate all that investment, they are very supportive of private sector investment coming in to provide the infrastructure they need. Now, while they need your money, you're pretty safe that you're going to get an acceptable investment return. And I would say this for any country in the world, when the government doesn't need your investment dollar anymore, get out.

Fair enough.

Fair enough.

And that's not emerging market- centric, that's any country in the world. While they need you, they will support you, and when they don't, look for a different investment destination. I just don't see that being the case within infrastructure, considering the amount of money that needs to be invested. I don't see that anywhere in the world, in my lifetime.

And that's not emerging market- centric, that's any country in the world. While they need you, they will support you, and when they don't, look for a different investment destination. I just don't see that being the case within infrastructure, considering the amount of money that needs to be invested. I don't see that anywhere in the world, in my lifetime.

Sarah, the way you're talking about it, it's understandable why the big super funds are buying up so many infrastructure assets, such as Sydney Airport, because of the longevity, the returns, the hedging, the whole lot. What's the big risk in investing in infrastructure though? We've spent 12 minutes or so talking about the benefits primarily. What's the big risk in infrastructure?

Sarah, the way you're talking about it, it's understandable why the big super funds are buying up so many infrastructure assets, such as Sydney Airport, because of the longevity, the returns, the hedging, the whole lot. What's the big risk in investing in infrastructure though? We've spent 12 minutes or so talking about the benefits primarily. What's the big risk in infrastructure?

So, I'll take it to listed infrastructure, if I may.

So, I'll take it to listed infrastructure, if I may.

Yep, yep.

Yep, yep.

Which is where we invest. And I think one of the bigger risks is clearly that we are in equity and we will move with equity markets. And we definitely saw that in COVID- 19. So the valuation gap between unlisted infrastructure and listed infrastructure widen significantly during the COVID-19 sell- off because the market reacted, and we believe completely oversold the infrastructure assets. That to us represented a significant buying opportunity. So, you do get these opportunities when the market overreacts. And look, the other big risk to infrastructure per se, and I mentioned that we think the government support is there, but any sort of these elongated assets. You know, governments are going to come and go, different strategies are going to come and go, you have to weather that, you know through the cycle. And the way we do that internally, is that we make sure that we're really, really comfortable with the strength of the judicial system in any country. So, if the government wants to try and change your contract or change your regulation, which is adverse to your investment profile, we need to know the judicial system will uphold the contract or regulation. So I would say the two big risks for us, two remain. Political, political noise, political moves, you know managing that environmental with social, that creates a lot of noise, and the other big one for us is that we do see in- cycle volatility, but is it a risk or is it an opportunity? And we tend to see it as an opportunity.

Which is where we invest. And I think one of the bigger risks is clearly that we are in equity and we will move with equity markets. And we definitely saw that in COVID- 19. So the valuation gap between unlisted infrastructure and listed infrastructure widen significantly during the COVID-19 sell- off because the market reacted, and we believe completely oversold the infrastructure assets. That to us represented a significant buying opportunity. So, you do get these opportunities when the market overreacts. And look, the other big risk to infrastructure per se, and I mentioned that we think the government support is there, but any sort of these elongated assets. You know, governments are going to come and go, different strategies are going to come and go, you have to weather that, you know through the cycle. And the way we do that internally, is that we make sure that we're really, really comfortable with the strength of the judicial system in any country. So, if the government wants to try and change your contract or change your regulation, which is adverse to your investment profile, we need to know the judicial system will uphold the contract or regulation. So I would say the two big risks for us, two remain. Political, political noise, political moves, you know managing that environmental with social, that creates a lot of noise, and the other big one for us is that we do see in- cycle volatility, but is it a risk or is it an opportunity? And we tend to see it as an opportunity.

Sarah, thank you for talking to Fear and Greed.

Sarah, thank you for talking to Fear and Greed.

Thanks very much for having me.

Thanks very much for having me.

That was Sarah Shaw, Global Portfolio Manager and Chief Investment Officer of 4D Infrastructure. This is a Fear and Greed Daily Interview. Join me every morning for the full Fear and Greed podcast with all the business news you need to know. I'm Sean Aylmer. Enjoy your day.

That was Sarah Shaw, Global Portfolio Manager and Chief Investment Officer of 4D Infrastructure. This is a Fear and Greed Daily Interview. Join me every morning for the full Fear and Greed podcast with all the business news you need to know. I'm Sean Aylmer. Enjoy your day.