By Sergiy Lesyk, director, research and analysis
The benefits of blending debt and equity to diversify a portfolio are well-known, and long ago gave rise to multi-asset investing. But whether investors can benefit from applying this same principle to listed infrastructure might be less obvious, as listed infrastructure equities can at times exhibit bond-like behavior. However, we've established that combining equity and fixed income listed infrastructure into a single portfolio can have several potential benefits.
Two levels of diversification
Listed infrastructure equities have historically been shown to offer diversification benefits when added to a broader equity portfolio—and our recent research shows that adding infrastructure bonds can further enhance diversification. As shown below, daily return correlations between equity and fixed income listed infrastructure have been low during the last 10 years, as have both 12- and 24-month rolling correlations over the past two years—with the exception of the COVID-19 crisis period when correlations rose.
From these correlation levels, it’s reasonable to expect that combining equity and debt listed infrastructure into a single portfolio can provide diversification benefits.
Diversification benefits are also evident if we look at adding fixed income listed infrastructure within the context of a broader portfolio. As fixed income listed infrastructure is negatively correlated with the broad US equity market, a 50/50 mix of fixed income and equity listed infrastructure reduces the portfolio’s correlation with the Russell 3000 Index from 0.72 to 0.61—illustrating the added diversification benefits of a multi-asset approach.
The potential for higher risk-adjusted returns
Combining listed infrastructure stocks and bonds can also offer the potential for higher risk-adjusted returns. In the table below, we’ve used different proportions of a debt and equity mix and calculated the returns and volatility of the multi-asset portfolios over the past 10 years. As shown, the various equity-debt combinations demonstrate an improvement in risk-adjusted returns in the multi-asset portfolio compared to single asset fixed income and equity indexes.
This table also illustrates how the addition of the debt component reduces the volatility and drawdowns of the portfolio, enhancing the defensive properties of a listed infrastructure allocation. Moreover, equity holders can view the addition of a fixed income component as a potential hedge against corporate distress in the event the covenants of the bonds are triggered, and the company has to restructure its capital. This can be particularly important given the high leverage of infrastructure companies.
Listed infrastructure equities bring their own benefits
It’s important to keep in mind that equity listed infrastructure can come with its own distinct benefits—and some of them are complementary to an infrastructure bond portfolio. For example, adding the stable dividend stream that infrastructure equities have historically provided can improve the yield profile of an infrastructure bond allocation. As shown below, the FTSE Developed Core Infrastructure Index dividend yield has exceeded both US Treasury and US Corporate bond yields in recent years.
Listed infrastructure equities also have the potential to serve as an inflation hedge, as infrastructure companies’ revenue streams are often directly linked to inflation. This is notably topical in the current environment, as the massive monetary easing that followed the COVID-19 crisis has put inflation back on investors’ agendas.
The tools for a multi-asset approach
Despite the pandemic, our research shows that the number of global infrastructure projects continued to grow in 2020. Looking ahead, the reopening story for global markets and a return to mobility collectively point to a continued focus on infrastructure spending. And as of the time of this writing, President Biden has just unveiled a robust $2 trillion infrastructure plan, setting infrastructure spending as a key priority in his administration’s agenda.
Amid these trends—and the demonstrated potential benefits of a multi-asset approach to listed infrastructure investing—FTSE Russell has introduced the FTSE Fixed Income Core Infrastructure Index Series as a complement to our equity infrastructure index series, introduced in 2011. This new fixed income extension is designed as a solution for infrastructure-focused investors looking to diversify and broaden their multi-asset portfolios.
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