Why infrastructure stocks can withstand higher interest rates | June 2017

The shock election of Donald Trump as US president sparked excitement that his pro-growth policies would reinvigorate the US economy. Talk these policies would be accompanied by faster inflation boosted US long-term interest rates by about 50 basis points over November. While Trump inspired a 14% rally in US equity markets that month, global infrastructure stocks fell 4% (as global equities overall rose 1.4%) because they were lumped among bond-proxy stocks that are considered to be vulnerable to higher rates.

The term bond proxy is often used to describe any security with bond-like features that benefited in recent years when low or even below-zero bond yields tied to ultra-loose monetary policies forced investors to look elsewhere for higher-yielding but still-dependable returns. Many turned to the safest of stocks including infrastructure stocks. After all, a primary characteristic of the infrastructure asset class is that the regulatory frameworks governing essential services generally ensure fair and predictable returns for owners.

The outlook is for tighter monetary conditions and higher bond rates. The Federal Reserve has raised the cash rate three times in the past 16 months because the US economy is progressing towards full employment. Recent evidence suggests that the global economy is picking up and seems to be winning its battle against deflation. This prospect of higher bond rates is prompting concerns that infrastructure stocks are set to underperform.

If interest rates were to jump then history suggests that infrastructure stocks would be likely to lag. But experience has been that this is a short-term phenomenon. Over the longer term, the relationship between infrastructure assets and interest rates is muted – whether rates are rising or falling. Interest rates have less sway on infrastructure stocks than many might think because these businesses are generally insulated from the business cycle. If interest rates were to rise, infrastructure stocks would be likely to recover quickly in relative terms, the more so because higher interest rates are already factored into infrastructure valuations.

Infrastructure stocks are certainly more sensitive to interest rates these days than the energy, materials and consumer-discretionary stocks that aren’t classed as ‘yield plays’. Circumstances could be such that infrastructure stocks could underperform. An unexpectedly large surge in interest rates would be one such circumstance. If rates rise modestly as expected, investors can be confident the embedded valuations and the protected nature of their earnings mean that infrastructure stocks are well placed to ride out the increase.

For more information on infrastructure stocks, or to discuss your current investments, please contact your Partners Wealth Group advisor directly or call 1800 333 143.


Article provided by Gerald Stack, Portfolio Manager, Magellan Asset Management Limited


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