Global Infrastructure: Putting Money to Work in Public Equities
In this episode of the All Angles podcast, seasoned portfolio manager Florence Taj provides fresh perspectives on why listed infrastructure should be on every investor's radar, and shares her unique insights on which long-term opportunities she invests in.
Vish Hindocha: Hello, and welcome to the All Angles podcast. In today's episode, we talk to Florence Taj. Florence has been at MFS® for over 25 years and served in a number of different teams and roles as you'll hear about, and it's really in her capacity today as the co-portfolio manager of our global infrastructure fund that I'm really curious about her perspectives on the asset class.
Now, global infrastructure is something that has caught a lot of asset allocators’ eye, and I think Florence has really interesting perspective on some of the compelling narratives and some new, differentiated thinking that she brings to the asset class and why people should be paying attention. We also touch a little bit on the debate between private and public markets, on emerging versus developed market considerations and on some of the more underappreciated themes and trends underlying this asset class. I hope you gain from this conversation as much as I did. Thank you for listening. So Florence, welcome to the All Angles podcast. We're delighted that you're here.
Florence Taj: Thank you.
Vish Hindocha: Before we start, you've been at MFS for 25 years in the investment team. Could you give us a brief bit of history going back maybe even further than that in terms of how did you get here? How did you get to the position of investment officer, portfolio manager of multiple capabilities and strategies, but listed infrastructure as well? Where did it all begin?
Florence Taj: I've always been very interested in investing and I started my career actually more in strategy consulting, which gave me a broad perspective on many different industries and executive challenges. So I liked the content of strategy consulting, but I didn't like the fact that you couldn't actually invest in any of the recommendations you were making. It was always quite theoretical. I went to Harvard Business School during my MBA. Between my first and second year, I actually got an internship at MFS. So technically I started in 1998 and not '99, so there’s even one more year to my tenure. I absolutely loved being able to invest behind my ideas. I loved the company and the fact that, at the time, it was very much a US mutual fund–focused company and we were just embarking on this huge global expansion and I thought that that was a really good time to join the firm and participate in that expansion.
And so I was working as a European analyst in the Boston office from ‘99 to 2004. The beginning of my career, I was covering European banks and consumer staples. And then in 2004, I actually moved to the London office and I've been here ever since. My coverage expanded to other areas. I covered tech hardware, I covered luxury goods, real estate until, basically, I pretty much covered the whole market as an analyst. I covered utilities in 2010, which is important for our discussion today. And while covering utilities, I basically realized that there was just a huge opportunity on the infrastructure front, not just in utilities but in many other areas of infrastructure. And that actually as a firm, we covered all these areas. We had people covering airports, railroads, pipelines, towers, telecom towers, but we didn't have a product that would encompass all these different sectors and that we could offer to our clients.
And the opportunity was, really, that these sectors that are viewed as very staid and not really growing, but in fact, as we can talk about in more detail, there are huge investment needs which are going to drive growth in this sector, and that's not really being recognized. So I basically suggested that we relaunch this product, and it went through the vetting process within MFS and then it became live in 2017, 2018. I've been running it ever since. We've expanded the team. So Scott Walker joined me in 2019 and Ben Tingling joined at the same time to help us basically market the strategy more broadly. So in a nutshell, that's how we got here.
Vish Hindocha: We will spend a lot of time on the listed infrastructure space. And as you said, it is a broad universe of different sort of sub-asset classes that have been covered for some time. Given you've talked about since 1998 joining MFS and having so much different coverage, is there anything you think about now as an investor, whether it's at this infrastructure space or even more broadly. How do you think your mental models for investing have evolved over time and how have they sort of been tested?
Florence Taj: It's a very good question in the sense that I think there are many people at MFS that are very long tenured, and I'm one of them. But it's not necessarily the case if we look outside our firm. I think we have a pretty exceptional set up here of having people who've stayed so long with the company and had the opportunity to see all these different cycles. The one thing that I've learned throughout is really not to be carried away by the prevailing sentiment. And we've seen that repeatedly. So in 2000, I remember I was covering banks, and banks were really out of favor because everyone wanted to invest in dotcoms. And whenever a bank would announce, for example, that they were launching like an online banking application, the stock would go up like 10% or 15%. It was just really ridiculous. And all these unwound spectacularly over the following years. And similarly in 2006, 2007, there was this euphoria everywhere. Housing prices were going up massively. Obviously it was all fueled by subprime, as we learned afterwards. You had oil prices at a hundred because the world was just growing and it was just all amazing, but then it was all dead fueled and it very quickly changed and morphed into a massive crisis.
And then as we sit here today, I can't help but seeing some of the same dynamics today that I saw in this previous instances. I don't mean to be the angel of doom today, but for example, there's been a lot of exchanges internally about AI, for example, and how it impacts various sectors and everyone is trying to find an AI angle. So the latest for utilities is that data centers are going to be built everywhere and they're very power hungry and therefore it's going to have a massive impact on power demand. And when you look at the details, actually it's probably like 3% or 4% impact over time. So it's really not huge, but that's enough to fire up people's imagination, which really tells you that there's this hunger for this theme and people are willing to pay whatever in order to get exposure to that.
And then we have these very, very positive narratives about the economy and rates having zero impact and growth continuing. I see a lot of imbalances behind all of this, and I do worry that maybe at some point there'll be a wake-up call to the same extent that I saw. So the learning is really to go beyond that facade and really watch for too much exuberance because, in my experience, it's always ended quite badly.
Vish Hindocha: Can end painfully for investors.
Florence Taj: And then maybe the second thing is, in that context, is to be able to find stocks that do well regardless of the perception in the environment. So not to buy something because you think rates are going to go up or down because inherently it’s just very, very unpredictable. There has to be a lot more to the investment case than just some help from the microenvironment. There has to be something really fundamental, structural long-term or some form of self-help where you are confident that no matter what happens, the management is able to deliver on the plan because they have it fully under their control. And we are seeing it at the end of last year, everybody thought rates would go down. Now people think at least in the US that rates may not even go down. Maybe go up. So it’s very dangerous, I think, to invest based on these seemingly attractive macro trends because there's a lot of volatility around that.
Vish Hindocha: That's really powerful. So stay grounded amid the euphoria. Beware the narrative fallacy a little bit. So be careful of compelling narratives and focus on fundamentals, not necessarily on the macro tailwinds that people might perceive to be there.
Florence Taj: Exactly.
Vish Hindocha: Make sure that you . . .
Florence Taj: Or the fads that people are trying to chase.
Vish Hindocha: Exactly. So actually that's a really neat segue into listed infrastructure because as I sit here and I talk to clients around the world, I know that this is a space in which there are some compelling narratives that are forcing clients to think about this asset class or this capability that maybe has been underrepresented in portfolios in decades past. So are we entering a new inflation regime? People talk about supply chain diversification, deglobalization, reshoring, onshoring and what the infrastructure capabilities will need to be in the investments that will need to be made in different regions around the world in order to make that happen.
How do you stay grounded? I'm just really curious on your perspective. What are you seeing in the asset class? How are you thinking about it? Are you seeing any interesting opportunities? How do you stay disciplined on the fundamentals and not get carried away by some of those things that investors and asset allocators around the world are looking more into this asset class as a result of some of those macro dynamics?
Florence Taj: So we are talking here about listed infrastructure. So these are companies that are listed around the world which are involved in basic essential infrastructure. That underpins all the growth drivers that we've been talking about. But specifically the type of companies that we look at in this space would be utilities. That's probably about 50% of our benchmark. Then there's a category called industrials, which is a bit of a catchall but is mostly transport. So that would be motorways, airport, railroads, ports, so that's about 20%. Then the rest is basically energy infrastructure. So pipelines or companies like Chenier, which has a huge LNG export infrastructure. And then the last bit is really telecom infrastructure. So things like telecom towers and REITs. They're classified as REITs in the US, but they're really telecom tower companies. So that's basically our space. We define it as such because all these companies have one thing in common, is that they have very long-term contracts and all very stable long-term regulatory frameworks where, essentially, there's a fairly low level of volatility in terms of the returns that they get that's all locked in and in many cases it's automatically inflation indexed.
Not always. Sometimes you're in situations where . . . For example, railroads. There's no automatic inflation indexing. But because they have a local monopoly, they essentially decide the price for their services. So they're incredibly well protected from an inflation point of view, and they tend to have very long-term contracts that limit the cash flow volatility under any kind of economic scenario. So that's really what we are focusing on. Obviously these stocks are listed so they move with the equity market, unlike some of the private funds that are also available for clients where the valuation there is a lot more subjective but less volatile. There are many advantages to listed over that, which I can talk about. But broadly speaking, you can get exposure to this space through the listed space, which is what we're suggesting, or through private.
And in terms of our investment approach, I think the key for us is really that stability and that predictability. So we are not interested in companies that are going to have a massive yield because they've levered up their balance sheet and they're paying it all back and then raising equity in the next cycle to start all over again. We don't want that. So we want companies that are growing in that space and that have a mix of existing assets that are producing cashflow and new opportunities to grow. So one of our large holdings, for example, is Iberdrola in Spain. That company has already established businesses in networks, power production, renewables around the world, but they also have a substantial pipeline of new projects that they will roll out over the next few years, largely on the renewable and network space.
In that context, we are looking for these companies that can grow. Obviously, a lot of these businesses are regulated, so we need them to operate in geographies where regulation is rational because sometimes you have a place where you have very high returns, but that usually attracts attention from the regulator because these companies have been given, in many cases, a monopoly. So they have to earn a fair return. So we always make sure that there's a fair return. And then we care a lot about the balance sheet of the company, the leverage, and obviously everything surrounding ESG and corporate governance. Also, the quality of their operations in terms of safety, because these are companies that build huge infrastructure projects. So they need to keep their workers safe, they need to respect the environment. So we take a very close look at that also as part of our investments. So when I started the fund, rates were very low, and then you had all these vehicles called yieldcos in the US, which were essentially financial engineering vehicles, which is what I described earlier, with a lot of leverage, big dividend in yields, issuing equity to buy more assets, which is really, at the end of the day, unsustainable.
And so we've avoided all of that, and rightly, so because those structures basically disintegrated as soon as energy prices went down and the cash flows from the underlying assets didn't come through. So there was no way to raise equity anymore and therefore it was game over. So we really don't want that. We're really looking at long-term sustainability of the companies.
We can talk more broadly also about . . . Because this sounds a bit boring, so you want this. So why is this space not boring? So what I want to say is it used to be very boring, but we've had these massive structural changes and the first big driver is really the energy transition and what it does to utilities and power production around the world. The growth in this space is not just an emerging market thing, it's actually very much a developed market issue. It's basically driven by the fact that the way we produce energy is changing. So in the 70s or 80s we built all these massive power plants, whether it's coal or gas or nuclear. And so you had this massive plant sitting in the middle of nowhere and you had a grid carrying the power in a star-shaped manner from that massive plant into people's homes or into businesses. But because now we are rolling out renewables, that whole power infrastructure is completely obsolete.
So instead of power being produced in that big plant, instead you may have this massive wind farm in Scotland, which you then need to connect again to businesses, people's home to the rest of the grid. Or it could be an offshore wind farm, in which case you need . . . Some of these wind farms are a hundred miles out to sea, so you need to connect that back into the grid for the power to be used. And similarly at the household level, you may have solar power suddenly on your roof, you may be charging your electric car overnight. And so all of that creates this massive strain on the grid, which didn't exist before. And so the net result of that is that you have a huge need for investment to build out the grid to be able to accommodate all these complete change in power infrastructure. And at the same time, you're getting a huge increase in electric demand because EV penetration is increasing. Transport is getting electrified.
Vish Hindocha: Electrified.
Florence Taj: Exactly. Corporates are also under huge pressure to update their infrastructure to reduce their carbon emissions. So they're also electrifying their production process, which means that power demand is rising, and then you have this whole grid that needs to follow. And so the net result is that, as you look at utilities around the world, a sector that used to be utterly boring and ex-growth is actually producing consistent mid-single-digit growth of their regulated asset base because their capex is increasing tremendously well above depreciation. So the asset base basically is growing and most of them get a fixed return on that, which is in many cases inflation-adjusted as well.
So if you look at US utilities for example, you look at all their projections pretty much anywhere in the US, they're all looking at growing EPS 7% or 8% per annum plus paying you dividend yield in a very secure way, in a way because the regulator wants these investments to happen to enable that energy transition. So the range of outcomes on these investments is low, unlike many other areas of the market where there could be a lot more uncertainty.
But if you look at telecom . . . is another interesting area. I think telco towers, the story there is that as 5G gets rolled out, you need to put a lot more equipment onto the tower because you need to densify the network in order to get enough power for that signal to get through. And they essentially get paid based on the weight of the equipment on the tower. So that's a big driver, especially in the US. And then in addition in Europe, you have an infrastructure that's not efficient at all in Europe because all the telecom operators have their own tower company, whereas in the US they've outsourced it all to a few big players.
So in Europe there's a huge need to consolidate that infrastructure. And if you consolidate two towers, it's like a jackpot basically because now you have one mass to maintain and you have twice the equipment on it and you get paid for that. So your incremental margin on that is very attractive. So again, that's a sector that looks incredibly boring, telecom towers, but where, because of digitalization and the growth in mobile data, we need to reinforce that structure. And I haven't even talked about emerging markets, which obviously there you have growth that requires this new infrastructure, or even if you take water, which is another big area that needs massive investment. You've seen the headlines here about sewage going into the sea and all of that. Everywhere you look, whatever infrastructure we built basically is no longer fit for purpose because it was built 50, 60 years ago. And because of all these trends and the way the world is going, essentially that infrastructure needs to be massively upgraded everywhere.
Vish Hindocha: And that's really fascinating, your role as an investor . . . And this is the bit that really fascinates me. How do you think about obsolescence? We've talked about some of our existing infrastructure. Even though these are very long-term contracts, 25-year contracts, naturally we're oriented towards the long-term as an investment house at MFS. But I'm curious how you think about the long-term nature of some of these trends and how these dynamic shifts are happening and get confidence in . . . And you said this right at the beginning. What is management's ability to actually execute on the things within their control? Any thoughts there on how you do that or how any of that has changed over the last few years as those new dynamics and paradigms are emerging?
Florence Taj: One of the risks in, as you say, in that transition is stranded assets. So you have a company that's got this amazing piece of infrastructure, but it's no longer needed. That explains for example, why we've been a bit cautious on the Canadian pipelines because a large part of the volumes are coming from Canadian oil, sand oil, which obviously is very environmentally unfriendly. And they are regulatory constructs within the Canadian pipelines to guarantee a return regardless of the volume of oil coming from these sources. So you're somewhat protected. But at the same time it creates uncertainty around the terminal value of those assets because that protection only lasts so long and you're probably better off deploying capital into something that's actually going to grow.
The other area where we're quite careful is around the gas infrastructure. We've taken the view that gas is going to be a very important transition molecule in terms of power and heat generation because the main issue with renewables is really the intermittency of the generation. So if you have a wind farm, for example an offshore wind farm, which is one of the most productive, it's the blades are probably going to produce only 45% of the time. Onshore would be more like 30%. And solar panels probably 15% to 20%. So what happens when the wind doesn't blow? When the sun doesn't come out? You need to have a backup and that backup right now, the most effective backup, is gas. Obviously there's nuclear as well. But as you know again that nuclear infrastructure is really almost reaching its end of life pretty much everywhere. And building new reactors is incredibly expensive and creates all these long-term externalities.
Vish Hindocha: And operates with huge lag as well.
Florence Taj: Exactly. And then we are getting better at battery technology also to try and smooth out those peaks and troughs. But fundamentally it will take time to make these solutions really economical. So we think gas infrastructure is probably going to be around for a while and a lot of the companies we follow are also retrofitting their grids so that they can transport hydrogen instead of natural gas. And so there's a lot of investment going into future-proofing those grids basically for that energy transition. So I think that's a good example of where there's definitely a question to be answered in terms of the durability of those assets into the future.
Vish Hindocha: But they can be adapted, which is interesting about your thoughts on hydrogen. So it's a compelling argument as to why the dynamics are shifting and why this is a really interesting space for investors that are interested in long-term, good risk-adjusted returns with interesting protections and less volatility. But you talked about you could access this privately and publicly, and that's obviously a debate that's gone on for a while. I've seen some research that says, to your point, obviously listed infrastructure is listed and therefore exhibits equity-like characteristics in the short term, but actually in the long term actually have fairly low correlation to listed equity markets and high correlations, things like inflation and some of the underlying dynamics.
But if I was an investor thinking, I believe everything Florence you just said . . . I've had it described as direct versus indirect exposure. I'm not sure it's totally right. But shouldn't I just go and buy some bridges or some toll roads or some critical infrastructure directly? Why should I access it through the listed market? What would you say to that?
Florence Taj: For the average investor, it's very difficult to access the market privately. So you need to have a significant mandate to be able to contribute to a private infrastructure fund. And on top of that, the fund itself will then buy the assets and manage them on your behalf because it'd be very difficult for you as an individual investor to. It's a big issue even for insurance companies. For example, I've talked to insurance clients and they said that they're able to invest in real estate directly and manage the building and it's simple. But managing a toll road or a wind farm is a completely different animal. It is complicated and you have all kinds of safety issues you need to think about. So unless you're just a huge, huge pension fund and you've got this internal infrastructure yourself to be able to manage those assets, most clients looking at private would do that through a fund.
And those funds, basically, once you contribute, you're going to be locked in for an extended period of time, whether it's 5 or 10 years. And the charging structure is a private equity type of model of 2/20, so 2% base fee and then 20% of any outperformance over a certain return benchmark.
And some of those funds have done really well and they're doing a really good job. But what I would point out is that it is just a different product altogether. First, they tend to have very few assets in the fund, so you're very concentrated, which creates its own risk. If something goes wrong with the regulation or the asset itself, obviously you're much more exposed. And then in order to generate a very high return on equity, they tend to put a lot of debt into the fund and they tend to have assets in there that are already very mature because that's when the cash flow really starts to come in. You can put a lot of debt in it, and then you pay down the debt and then your return on equity goes through the roof. And that's fine. So that's one model. And the advantage you have as a pension fund is it's not volatile. Well, at least not in the short term because it's not really mark to market. And it's mark to market, but using internal models which may or may not be fully reflective of what's happening. And we've also had instances of funds sending assets to each other in order to get better marks. So there's a lack of . . . I'm not saying that . . .
Vish Hindocha: It's not as transparent.
Florence Taj: It's not as transparent, exactly. So you can question the variation because it is based on internal models. So that's private. So that's one way of doing it. What we're saying is that listed, okay, yes, they're listed, they're on the stock market, therefore they're going to be in the short term much more volatile. But over the very long term, when we look at the returns of the infrastructure index, the listed infrastructure index and the private, actually over a 10-year period, there's hardly any difference. And the advantage of listed is that you're going to be very diversified. So if you look at the listed market cap index, it's something like three trillion that we can invest in that's liquid enough for us to invest in.
And on top of that, the charging structure is obviously going to be more like an equity fund, not a private fund, so it's substantially cheaper. And also no lock-ins. So if you want to reallocate your capital at some point you can. And these assets are very liquid. The average market cap in our benchmark is probably, I think, around $50 billion. It's not an issue at all. So it gives you a lot more flexibility, a lot more diversification. You can invest globally, you can have assets in the US, Europe and Asia. We invest in emerging markets as well. So it's just a lot more flexible as a structure and a lot cheaper. And the other thing which has been very interesting is that, in many cases, listed companies have traded at a discount to what is being paid on the private side. So for example, recently Cellnex disposed of some assets in Ireland. And Cellnex itself is on 12 to 13 times EBITDA. They sold the Irish assets above 20 times to private player. Because those funds are sitting on a lot of dry powder and they are keen to snap up large assets and therefore there's a lot of competition on the private side to bid for these assets, and you can get access to that much cheaper via listed companies. So I think that's why it's interesting because there's also a valuation arbitrage between listed and private.
Vish Hindocha: That's fascinating. That valuation arbitrage is not a point that I had ever fully appreciated before. Sometimes when we set up these . . . We often see this in the investment industry and that's allocated everywhere. Should I go private or public? And whenever it's an A or B choice, I always wonder if it's secret option C. Are they actually complementary? So could it be a mixture of the two? And maybe you answered it just then at the end, but I was curious on your thoughts as well.
Are there meaningful differences between what the private markets are able to access and accessing in public? So I think you've answered it in terms of whether it's market cap, geography, but that valuation arbitrage point is one that I hadn't considered before. Are there other ways in which you think they could be complementary? Again, lots of asset allocators who are interested in the space could probably do both. It's not often a choice for people of doing one or the other. Are there any other meaningful differences to your eye in terms of what you should expect someone like yourself to access versus a private markets player to be able to go and source?
Florence Taj: I think the difference is probably on the private side you can be a lot more precise in terms of the asset that you're buying and the characteristics and the contract. We don't go into the nitty-gritty of every single contract that underpins Iberdrola's renewable investments, for example. That means you'd be a lot more concentrated and then you'll have to manage that asset day to day, which is not something that we do.
I think the difference for us is being able to access this huge portfolio of growth opportunities. We don't really want just mature assets. We want that pipeline of growth. And I think that's the key differentiator is that pipeline of growth, that diversification that we are able to bring to the table. And I think yes, they could be very much complimentary. Sometimes you commit to a fund, for example, but you don't get the cash call for a while because they can't find the opportunities to invest in.
So in that time, you could have your exposure, your cash in listed infrastructure, and you're getting the same exposure to the same assets until perhaps you put it in that private structure, if you wish to do so. But I think also we are at a unique point right now where . . . because of the rate volatility and this perception that these are still very much bond proxies. Actually, the sector has been under pressure over the last couple of years in the listed markets. Whereas on the private side, a lot of that valuation markdown really hasn't taken place yet. We’ve already had a significant mark to market of assets on the listed side, which hasn't necessarily happened everywhere on the private side.
Vish Hindocha: Interesting. The last question for this section is around what do you believe that maybe few other people believe, when you think about amongst your peers, or as you access investment opportunities that you are picking up that very few people in the market seem to counter as prevailing wisdom?
Florence Taj: Another differentiator for us is to be very aware of the governance side of things. That's part of the reasons why actually we're finding relatively few opportunities in emerging markets. Because a lot of infrastructure assets, by definition, are either under full control of the government or part of a family empire, which is not always very, very transparent. So one example is the Adani group. Adani Ports is a big component of our benchmark in infrastructure.
And while the port assets, I think very good quality, we've always been very circumspect around the overall structure of the group. And I'm sure you saw that there was a very controversial Hindenburg report about Adani group and some of the practices in terms of purchasing their own stock through vehicles in Mauritius and in London. And there was this whole lack of transparency around the group, which means that we've always stayed away from that. And so generally we are very cognizant of that. And so that means we may decide to stay out of large stocks in our benchmark because we are just not comfortable with the setup and the governance within the company. So I think that's probably something we try to be very disciplined around. I'm not sure how our competitors think about it, but that's definitely something that's . . .
Vish Hindocha: That's front of mind for you.
Florence Taj: Front of mind for us. Yes.
Vish Hindocha: Particularly given the long-term nature of that asset class.
Florence Taj: Yeah. Exactly. Exactly.
Vish Hindocha: Is there any last message that you would have for our listeners? What's the one thing that you would want them to be thinking about this moment in time?
Florence Taj: Getting back to maybe the conversation around infrastructure to think about this over the very long term. I think that is the key message. This is not about one quarter or two quarter returns of volatility. I think this is a theme that's going to carry on for the next 20 years, where as a society, we're going to have to address all these underlying issues and they're already impacting our daily lives. And definitely I think a lot of money is going to have to be channeled in that area to resolve these problems and rebuild the infrastructure that we need.
Vish Hindocha: That we need. That's a beautiful place to end it. Florence, thank you so much your time and insight today.
Florence Taj: You're welcome. Thank you for the questions.
Vish Hindocha: Thank you.
Speaker 3: The views expressed are those of the speaker and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as an offer of securities or investment advice. No forecast can be guaranteed. Past performance is no guarantee of future results.
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