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Diversification Through Infrastructure Assets
Cohen & Steers Global Infrastructure Fund
Interview with: Ben Morton

Author: Ticker Magazine
Last Update: Jan 25, 11:03 AM EST
The growing interest for diversification away from equities and fixed income has been the driving force behind the Cohen & Steers Global Infrastructure fund. Portfolio manager Ben Morton believes that the asset class can provide similar returns to equities, but with the potential for significantly lower volatility and downside. The fund utilizes both a bottom-up fundamental research and a macro framework to select the right subsectors and companies around the world.

“If not monopolies, real-asset infrastructure companies often are duopolies or oligopolies. Ultimately, they have the value of the hard assets and their businesses are very difficult to replicate. These characteristics may lead to predictability of the cash flow.”
At the core, we are bottom-up fundamental analysis stock pickers, but I wouldn’t downplay the importance of the macro overlay in our process. Over the years, about a third of our alpha has come from subsector selection, which is directly tied to that macro overlay. Nevertheless, we focus the vast majority of our time on bottom-up stock selection, and that’s where most of the risk in the portfolio lies.

We also have the benefit of leaning on a dedicated macro research team, which is a great resource. We come up with our specific framework for infrastructure and the input for that framework, but we have resources at our disposal to help inform our views.

Q: Would you give us an example of an investment to highlight your research process?

A: One of our favorite themes is U.S. cell tower companies, which are a great representation of core infrastructure, in our view. They lease out space on their towers to wireless carriers under long-term contracts – on average seven to nine years in duration. There are revenue escalators that may not be directly linked to inflation, but typically represent 3% to 4% increases every year.

We have an analyst in New York who is dedicated to covering the U.S. cell tower companies. He does the bottom-up work on companies building financial models, forecasting cash flow and earnings growth, balance sheet conditions over time, evaluating management, etc. These companies came on the radar as attractive from a fundamental perspective.

Cell towers are less regulated, which is a favorable characteristic. They are commercial infrastructure businesses with the most visible medium-term growth rate of any subsector within infrastructure. So, the cell towers score well within our macro framework, as well in the overall valuation framework among the subsectors.

For each subsector, we have a model that lists all the companies in that global space. That model ranks the cell tower companies based on the two most relevant valuation metrics. The first one is the upside or downside to our net asset value, which is typically driven by discounted cash flow valuations. The second metric is the cash flow multiple relative to the growth rate of adjusted funds from operations. Based on these two metrics, the model screens the most and the least attractive global towers.

The model captures and quantifies all our fundamental views on the companies and the macro conditions that affect them, which are included in our discounted cash flow analysis, and reveals the securities within the tower space that we should own.

Q: Could you cite another example?

A: Another example would be European airports, where the investment thesis is based on expectations for a rebound in passenger volumes, which would drive growing cash flows. A handful of listed companies in the European airport space had very weak passenger volumes last year largely because of terrorist events. We expected to see a material rebound in terms of passenger volumes to drive performance.

The second factor, which made the subsector compelling, was related to the private transactions for stakes in airports at 15, 20, or 25 times year-ahead cash flows. At the same time, the European airports were trading at nine times year-ahead cash flows. With more than $150 billion sitting on the sidelines, private funds are paying much higher multiple premiums for these assets than on the listed markets. We believed that this dynamic was unsustainable, and that listed valuations would rise as a result.

European airports indeed performed extremely well in the first-half of the year, recording double-digit growth, and both factors were at work. There was fundamental improvement in year-over-year passenger volumes due to the abnormally low volumes in the previous year. Also, the overarching view that private money continues to focus on a finite number of transactions and private funds are paying extremely high multiples, started to positively affect valuations. Now more investors look at listed infrastructure and private transactions in the airport space have supported a very strong return this year.

Q: Do you think your strategy is affected by an Anglo-centric approach?

A: When investing in 20 different countries around the world, we can’t have an Anglo-centric focus. We need to be willing to understand the cultural, the regulatory, and the political climate in various parts of the world. That’s especially important in infrastructure, because these are local assets that are heavily affected by regulations and politics.

As we developed our team, we didn’t just send someone from the New York office to London to look at this universe in Europe, which is largely continental. We actually hired a French national, who speaks four European languages and has 17 years of experience in Europe covering infrastructure companies. She has been with us for seven years.

Our analyst in Hong Kong is Chinese; she is also not a U.S. or an Australian transplant. She grew up in Shanghai and has been covering Asian infrastructure for 11 years, more than seven of those with us. Her universe includes not only China, but also the Asia-Pacific region.

We took the approach of hiring people with broader experience in their respective regions. We give them the resources they need for covering their entire universe and the resources to travel to all the markets that they are responsible for.

Q: How is your portfolio constructed? And how important is diversification?

A: We typically own between 30 and 50 names in the portfolio. We aim for diversification in terms of geography, subsector, and security exposure. We have minimum levels of exposure to each major region of the world.

We have the flexibility to take material underweight and overweight positions in each of the subsectors relative to the benchmark. Our official benchmark is the FTSE 50/50 Global Infrastructure Index. Philosophically, this is a long-term, long-duration, asset-type strategy that looks to outperform inflation, but we recognize that there is an equity wrapper to it and we needed a benchmark that relates to listed equities. The FTSE 50/50 is most representative of the opportunity set in the core infrastructure universe.

We have a limit of 10% on each individual security weight. If the subsector is less than 10% of the index, we can go up to three times the index weight. If it’s greater than 10% of the index, we can be two times the index. We generally expect that 75% or more of the portfolio’s tracking risk will come from security selection.

Q: How do you define and manage risk?

A: Risk management involves ongoing and constant review of qualitative and quantitative risks by the portfolio management team, as well as by an independent risk analytics team.

As a firm, we consider risk to be an opportunity in some cases. Some risk has to be taken to drive the returns and the alpha that our investors expect. Those risks need to be managed appropriately in the context of the conviction of our alpha views.

We believe that macro and micro risks affect the companies in the asset class, because they tend to be more regulated and politically influenced businesses. The biggest risk that we face on a day-to-day basis is managing our views to potential regulatory and political outcomes.

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