MASTERCLASS: Inflation - May 2021
April 20, 2021
Jenna Dagenhart: Welcome to Asset TV. And thank you for watching this infrastructure masterclass. We'll cover the impact of COVID-19 and synchronized climate goals. How the asset class has evolved over the years and where our speakers see investment opportunities today. I'm joined now by Nick Langley, Managing Director and Global Infrastructure Strategies, Portfolio Manager at Clearbridge Investments and Josh Duitz Portfolio Manager of ASGI at Aberdeen Standard Investments. Everyone thank you for joining us and Josh starting with you and setting the scene here. What is infrastructure?
Josh Duitz: Infrastructure is broadly defined as essential assets the society requires to facilitate the orderly operation of its economy. It's really these central assets to allow the economy to grow and to increase productivity, it's become a necessity. But we break out into infrastructure into four broad categories, the first being transportation, and that includes roads, rails, bridges, airports, and seaports. The second category is utilities, and that's your electric utility, your gas utility, your water utility, again, as an essential asset that we all need.
The third category is communication and that include, so your wireless networks, the towers, the wireline networks. So, communications are a big part of the infrastructure universe we believe. And the last category is the energy assets. We're not talking about the EMPs exploration and production side of it, but really the midstream assets, the pipelines that have taken or pay type contracts and they don't take much commodity risk there, although that's a smaller part of it, it's still part of the infrastructure universe. So those are really the essential assets that allows an economy to continue to function.
Jenna Dagenhart: Nick, how would you define infrastructure?
Nick Langley: Thanks, Jenna. We broadly agree, although we shaved some of the edges of. Our business began from trying to replicate private markets, infrastructure strategies. And so, we take a very strong focus on core infrastructure. So, anything that has commodity price exposure we tend to exclude from our investment universe in a thing that has a retail like exposure. So, if you're a communication, the wireline business like a Verizon or a Vodafone you're exposed to customer churn and kind of a retail aspect to the business. And so, we tend to exclude those companies. So, what we're really looking for is companies that have very stable cash flows over a long period of time. And that lends itself to the utilities, as Josh mentioned, gas, electricity, water.
For us really, we're talking about the poles, the wires and the pipes. And then on the GDP sensitive side, the true infrastructure, anything that's involved in moving people or goods around the economy. So as Josh said on the transport side, now the roads, the rail, the ports, the airports and we will extend into some of the communications infrastructure, but we really tend to stop at the wireless tower businesses at this stage. So again, what we're looking for is long-term stable and predictable cash flows that are generally inflation-linked. They're going to provide those steady returns to investors over a long period of time.
Josh Duitz: And I agree with Nick, I think we try to avoid commodity risk, and that's why I mentioned we don't really invest in the EMP. And I think 2020 was a great example of that, where we look at the type of companies on the midstream side that we invest in, even with COVID and oil prices, at one point going even negative, their earnings were stable during that time period. So, the steady, predictable cashflow is a huge component of it. And likewise, on the communication side, we absolutely prefer the towers, and we think there's great growth there. So, I would agree with Nick.
Jenna Dagenhart: And the different types of infrastructure and the infrastructure that we need today is very different than the infrastructure that we needed 10, 20, 30 years ago. Nick, how would you say that infrastructure has evolved over time?
Nick Langley: Yeah, so that's an interesting question. Our view generally is the core infrastructure hasn't changed that much. I mean, the way we use it changes, think back over time, you take roads as an example the nature of the roads hasn't really changed. And at one stage we had horses and buggies, okay. The roads got an upgrade and we've got cars and soon we'll have autonomous electric vehicles. But the nature of the road hasn't really changed. We have learned to use them more efficiently. So, for example, in the US now we have these things called hotlines where you get variable pricing. And so, at peak hour, they cost a lot more to utilize and off-peak hours they're a lot cheaper and it's a way of managing traffic flow and things like that.
Similarly, when we think about our electricity network if we roll forward in time, the public policy is directing us towards essentially decarbonizing our economies and that's broadly meaning move everything that we can to electricity and then power the grid with as much electricity as possible. So, the poles and the wires aren't going to change the way we use them will change, will become a lot smarter. It used to be in the old days that electricity only flowed one way, well, there are going forward it may flow both ways. For example, you may draw electricity to charge the car in your garage in the future. But at a point in time your car may actually the supply of power and you may sell electricity out of your car battery back into the grid. So, there's a bidirectionality will become important over time. And then obviously changes the tech and so on that's in the network, but broadly we're still poles and wires. And that will be the case for quite some time to come.
Josh Duitz: I would think the attractiveness of the different infrastructure assets are important. I would say looking back about 10 years ago, we talked about utilities, especially in the United States we talked about the energy efficiency of consumers and the products, the light bulbs are becoming more efficient, and utilities didn't see message attractive investment going forward. But what has changed over the past 10 years is government policy and climate change. And now there's investment opportunities for utilities on the renewable side. So, I think that's one change. A couple of other changes along with climate change is they talked about the energy renaissance in the United States and fracking and drilling for more natural gas and more natural gas pipelines. Well, natural gas will probably still grow for the next 10 years as a source of energy. I think over the longer term, we're going to have much more renewable.
So that has changed and that's one of the reasons we've consistently been underweight in the midstream type pipelines and the energy exposure. One other huge change, I would say over the past 20 years is the most attractive part as Nick and I said, of the communication sector or the wireless towers, right. We look back 20 years ago, 25 years ago, we were only using phones within our house. They're all wireline phones. And then we moved to cell phones. And then the next thing we did is we started with smartphones. And if we remember the beginning of the smartphone era, we were all on our RIM, our Blackberries, all we did is use our smartphone for sending out emails to each other, rather than what we do now with our smartphones, whether it's on a Zoom call today, or whether our kids are on Zoom learning from home, and that has changed dramatically.
And that's really brought about the need for the wireless towers and the macro towers to enable the cellular communications. So, I think that has been the biggest change in the portfolio over the past decade and certainly over the past 20 years.
Nick Langley: I think Jenna when investors are thinking about investing in infrastructure, it's really important to understand the returns for these companies are generated from their asset base. So, it's really an investment in real assets and an understanding as to the return profile, those assets will provide over time. So, whether we're talking regulated companies, particularly in the utility space concession companies, a lot of those in the transport space or as Josh mentioned, some of the wireless towers with long-term MLS or contracts for use of those, that tower infrastructure, really that companies that are going to do well over longer term are those that are able to invest in their asset base and earn an appropriate return. Unlikely to earn super returns in this space because there's a lot of regulation and because you're an essential asset or a monopoly.
But ultimately what we're looking for is steady earnings, cash flows and dividends generated from a growing asset base and a regulator or some sort of contract that is giving us confidence that we're going to work on an appropriate return over a long period of time. So, as we think about technological change our view is it's important to consider core infrastructure and those physical assets, and will those physical assets continue to be utilized into the future.
Jenna Dagenhart: And infrastructure really is core with the recent events in Texas exposing some of those vulnerabilities in America's infrastructure. How do you see the country moving forward to remedy these issues?
Nick Langley: Well, there's a substantial investment required in US infrastructure period. There has been a long decade, long timeframe where there's been underinvestment across water, across electricity. Gas has been catching up obviously with the energy renaissance over the last few years. But there's simply an incredibly large amount of capital expenditure required to rebuild and refurbish a lot of existing infrastructure. And to build out a bunch of new infrastructures, as Josh mentioned the renewable sector in the US is, you're going to spend hundreds of billions of dollars over the coming decade to build out more renewable energy be that onshore wind, offshore wind, solar. There will be a lot of batteries used by utilities to kind of manage the load on the grid and situations like Texas most recently, or California fourth quarter of last year we have some challenges around the variability and volatility of weather which plays a significant role in the amount of say electricity that we utilize. So, we've spent a lot of money to improve our grid resilience.
Josh Duitz: We spend about 2.3% of our GDP on water and transportation infrastructure, which is the lowest level in at least 60 years or so. There are 240,000 water main breaks a year. And that's before all those water main breaks we saw in Texas over the past couple of weeks. We need to spend more, it's not an option to spend more. So, I think that'll take place over the coming decades. And that to me is a big opportunity in developed markets. It's really rebuilding our infrastructure.
Nick Langley: When we look at those developed markets, generally, we've got the regulation in place to manage private capital going into the infrastructure space. And the publicly listed companies are some of the biggest sources of private capital into the infrastructure space. Governments really don't have the headroom on their balance sheets, post pandemic to undertake a lot of infrastructure projects. They need to stimulate the private sector to provide capital and provide an appropriate return on that capital for private sector investors like us.
Josh Duitz: I think that's so key of the private sector involvement in it. And you see that in the renewable space and on the roads, Nick mentioned earlier where they have congestion pricing, those are really built by private companies. I mean, private companies, meaning companies that we can invest in on the public side of the market. So, I think that is a key to help him fix infrastructure. And we see it's done well and done efficiently by the private sector, much more so than the public sector.
Jenna Dagenhart: Yeah. And on this topic of infrastructure needs, Nick is an infrastructure bill in the US more likely now with the Biden administration in the White House. And what kind of opportunities might an infrastructure spending bill offer?
Nick Langley: Yeah, I think it is more likely, it largely has bipartisan support or at a conceptual level, obviously the devils in the detail with these things. And if we think back to the Trump administration, he obviously had desires around the infrastructure side. The plan was to spend 250 billion of federal money to stimulate around one and a quarter trillion of investment into the space. So, it was kind of 250 billion by the feds, a trillion dollars from the private sector kind of a four to one ratio there. So, the Biden bill is rumored to be somewhere between two, maybe as high as $3 trillion. And that's going to be a pretty significant investment, and you can expect that there will be some leverage on that, there'll be a lot of private sector involvement as well.
And so, as we mentioned before we have regulatory arrangements in place to support the construction of new infrastructure assets and to manage the process of raising private capital and building the project, and then earning a return on that project from a number of consumers of that product or that project. And so, we can expect a large amount of private capital to flow into infrastructure and Biden has targeted a number of areas. The water infrastructure that Josh mentioned before has been severely under invested in and 85 plus percent of that water infrastructure is owned by local units. So, there are, again, frameworks in place to transfer those assets into the private sector and have the private sector invest a lot of capital in those. And we're also looking at investments, obviously in the renewable space. There is electrification of some of the freight rail networks in the US that's being targeted and a lot of infrastructure around 5G and the rollout of 5G network. So that goes to the wireless tower businesses that were discussed before as well.
Josh Duitz: I think it's very important what Nick said that traditionally, you hear about infrastructure, and everyone's going to talk about roads and bridges but really, it's evolved. And it's not only fixing the roads and bridges, which are extremely important in the mortar pipes, but it is now spending on renewable energy and spending on broadband because really the Biden administration is focused on economic disparities and the income divide. And we're able to work on home, because we have a broadband connection and our kids could go to school at home because of the Zoom on and abroad that connection, not everyone has that. And it shows because there's pandemic an essential asset that broadband connection is. And that is probably will be part of the spending on any infrastructure plan in the United States. And in Europe, I should mention also the EU Recovery Act.
I'll just mention that because I do think it's important. The EU Recovery Act, which was a 750 billion Euro bill, and that doesn't even include the EU budget in that there's about 20% to 25% focused on green infrastructure and another 150 billion focused on digital. So, they're focusing on both renewable and the broadband and digital side. And that was a largest stimulus package Europe has seen since the Marshall Plan.
Jenna Dagenhart: So public policy and fiscal stimulus are having quite an impact on infrastructure investments.
Josh Duitz: Yeah. And with the stimulus, right, when we talked about all the packages we've had in the United States, and the 1.9 billion that they're talking about, those are really stabilization bills, right? That's not stimulating the economy. Infrastructure package will stimulate the economy and because there's a multiplier effect to spending on infrastructure. So that will help us to start growing again. And that's what's so important about spending on infrastructure. It increases the productivity of the economy and eventually it helps on the standard of living rise.
Nick Langley: Yeah. In general, when we talk about the implementation of these infrastructure packages and Josh we've been talking about the US, Europe, most developed countries around the world and a lot of the emerging markets are looking to stimulate their economies with an infrastructure bill. And the reason for that is that you're using local aggregates, you're using local labor supply contractors and so on. And so, as Josh said, there's a multiplier effect for every dollar that you put into that project that ripples through the communities. And that then allows to raise their living standards within particular communities as that project is being built. And then you hope if you're building the right projects over time, that that means the economy is more efficient. Goods, services are able to trade more freely with less friction, and that should give an ongoing GDP benefit from that infrastructure build.
So, it's kind of a double whammy. You get the GDP benefit from the construction of the project. And then you've got an ongoing what we call an efficiency dividend. And in that context the public sector has a very strong role to play in terms of directing which projects they want done. The private sector is generally better at the construction side of it and getting those delivered on time and on budget. And as Josh and I look at the market, we see a number of the listed companies being incumbent players in their geographic regions particularly across transport and electricity and so on. And so, they will be the beneficiaries of some of the directed expenditure. They've got access to lots of capital. So, we'll build the projects, and we learn an appropriate return on those projects over a long period of time.
Jenna Dagenhart: And we're hearing a lot about inflation with all of this infrastructure spending and stimulus and capital expenditures. Nick, do you think inflation will be an important factor to consider a mid-huge stimulus spending and more organic economic recovery? And how are you looking at it in your portfolios?
Nick Langley: Yeah, it's certainly a topic de jure and we do expect more inflation to come through, at least in the near term. Most of the infrastructure companies have some direct or indirect link to inflation over time. Direct typically in UK, Europe down through Asia where inflation becomes actually a pass through for the infrastructure companies. Indirect particularly in the US where there's a lot of nominal return targets. And so, as inflation goes up the next time you see your regulator, your nominal return target actually increases. And so there we talk about an indirect link to inflation. So, as we look at our portfolio, for example, in our income strategy, more than 90% of the exposure of the portfolio has a direct or indirect link to inflation.
So, for infrastructure companies, inflation is largely a pass through. It's one of the very attractive features of investments in infrastructure. We will also see that inflation play into bond yields. And we've obviously seen that recently over the first couple of months of 2021. And that will continue we think until bond yields reach a more viable long-term level and kind of an equilibrium in the economy. So broadly inflation is a pass through for the infrastructure companies. So, we're actually positively correlated to inflation. And as you think about how inflation plays into the economy itself; you're going to end up with higher bond yields which is one of the key valuation metrics for infrastructure. That will provide a bit of a headwind for some of the more defensive utility investments as those bond yields are normalizing. But actually, it's more of a tailwind for the transport and the more GDP sensitive infrastructure particularly if those bond yields are rising, because people think the economy is getting better, which will be the case this time.
Jenna Dagenhart: Josh, would you like to weigh in as well?
Josh Duitz: I do think we're going to see inflation. If you just look what happened last year when the fed increased the balance sheet, 80%, the BOJ increased to 25%, ECB 65%, and then you throw in all the fiscal stimulus as well. There's just been so much money thrown at the problem with COVID and the pandemic. So, we do believe that the inflation, and as Nick said so many of the assets that we invest in have an inflation linked to it. When we look at infrastructure here, what is one of the big risks for it is interest rates going high, but that's really if real rates are going high. So, if interest rates are going high, because inflation's going higher, there's generally an inflation protection component to many of the assets we invest in. So, we saw interest rates going high without inflation, that would be a risk for it.
Jenna Dagenhart: Going back to the point on utilities next, some people might think that they already have a significant exposure to infrastructure based on their utilities holdings and say the S&P 500. Is that a fair assumption?
Nick Langley: No, not today. So, if you take the broader category of infrastructure utility, the transport companies and the like you're looking at less than 5% of the S&P 500. So, if you have a general equity exposure, yes, you have a little bit of infrastructure exposure, but really not a sufficient amount to provide that infrastructure investment characteristic to your portfolio.
Jenna Dagenhart: So how does infrastructure fit into the portfolio?
Nick Langley: We find that clients are using infrastructure as essentially as ballast in their portfolio. So, it's a more defensive category. It's a longer-term real asset with inflation protection properties. And so, as result, people are often putting infrastructure alongside say, REIT exposures in their portfolio to provide that real asset inflation linked kind of defensive component to the portfolios. What's been interesting through the pandemic. And if you go back to the GFC similar occurrences there, the REIT sector was a little bit more procyclical in a significant downturn. And that's because the REIT companies tend to have their vacancies go up when a recession occurs, they need to increase the level of incentive payments to get new tenants to come in and so on. And so, they tend to be more procyclical than infrastructure, which really generates a return on the underlying asset base. So as long as the companies have access to capital and the amount of liquidity being pumped into markets that's a given, they can continue to invest in their asset base and as they grow their assets, they grow their earnings, their cash flows and their dividends.
Jenna Dagenhart: Josh, are there any misconceptions you'd like to address about what infrastructure is, what it isn't or how it fits within the portfolio?
Josh Duitz: I think the biggest misconception I come across is by retail investors in the United States. And they think that infrastructure is invested in the cats and deeres of the world. And those are really cyclical companies, and they might be great companies, but that's not what we're really trying to invest in within infrastructure. We really want to own the owners of infrastructure. So, we want to own that toll road. We want to own the airport. We want to own the wireless tower.
Jenna Dagenhart: And looking more closely at various opportunities. Nick, how would you characterize the opportunities for infrastructure investors in the developed world versus the developing?
Nick Langley: So in the developed world, we are spending and need to spend a lot more money refurbishing existing infrastructure and that's the poles, the wires, the pipes, the roads, the bridges, and so on. And as we refurbish that we will add a little bit of technology to a lot of that infrastructure to improve the flow of electricity and add battery stacks into our utility networks and so on. But the focus is really on the refurbishment first and then building out of some of the bells and whistles in the infrastructure.
In the emerging markets it's a lot more about the growth of the underlying economies. So, we've got economies growing at rapid rates, high rates of inflation in the emerging market. And you've got significant both population growth and populations becoming wealthier as those countries are emerging.
And as those populations become wealthier and richer middle class, they want to own a car, they want to own a house. So, you need more infrastructure to support the development of those populations. And then once they reach another wealth level, they want to start traveling. And so, you need more airports and so on. So, in the emerging economies, it's about kind of growth of the underlying economy and supporting the population both growth and as they become wealthier. In the developed markets, it's more about the refurbishment of the existing infrastructure is where we've got to spend a lot of our money.
Josh Duitz: So if I could add something there. So, I would agree in developed markets where we really have to refurbish our infrastructure, but now we're taking the next step of building new infrastructure for the new economy, whether that is for the communication side and also for on renewable energy. So, I think that is the growth opportunity in developed markets besides for the refurbishment of the old infrastructure, which is crumbling. And as Nick said, it's about population growth, but it's not only about population growth. It's also about urbanization in emerging and developing markets. If you look at the world's population, it's doubled over the past 50 years, but the number of people living in cities have tripled over that time. And if we look at 30 years from now, the world's population is supposed to grow another 30%. And the number of people migrating or born into cities is supposed to grow by 65%. Most of that population growth, like 97% of the population growth is expected in developing economies. So as Nick said, it's about building out that infrastructure, especially in the cities within those developing and emerging markets.
Jenna Dagenhart: And going back to green infrastructure, Nick, how would you characterize the opportunity for infrastructure given what seems like a synchronized focus on climate in the US, Europe, and China?
Nick Langley: In short, it's substantial. The international energy agency, which does a forecast of infrastructure spending in the energy sector in particular, focused on renewable energy and decarbonized economy is forecasting based on current public policy. 800 billion US dollars a year over the next 20 years in really focused the poles and wires and pipes space. Now there's additional over and above that to actually build out new, renewable energy and so on. And if you move to a path that sees all countries meet their obligations under the Paris Climate Accord that number's North of a trillion dollars a year. And again, that's just on the poles and wires and pipes, and then we've got additional on renewable energy and so on. So, there is a huge amount of capital to be spent.
Thankfully we've got great liquidity and access to that capital in the listed markets. And we have those regulatory frameworks in place to help ensure that ADS get built on time and on budget. And it be the investors in those projects earn an appropriate return over a longer period of time. So, the question then becomes well as an investor how do you think about investing in that thematic? And it really comes down to your time horizon and what you're looking for infrastructure to do in your portfolio.
The more stable ballast like you want in the portfolio, the more you should own those poles and wires and pipes, which are going to earn a steady return over a longer period of time. The more sizzle you want in the portfolio while there are some other investments thematic technology development around the battery space and significant build out by renewable companies. Some of those returns will be competed away. So, there is some element of risk in some of those companies. But think about that broader thematic providing a tailwind for infrastructure investment and infrastructure returns for at least the next one to two decades.
Jenna Dagenhart: Josh, I know you're passionate about these issues as well. Any thoughts on green infrastructure, renewables, or going back to what you said earlier about more people trying to go carbon neutral?
Josh Duitz: Roughly now about three quarters of the world's economies judged by GDP have agreed to go to climate, to be net neutral, zero emissions. So as Nick said, the tailwind is huge, and I've seen all types of numbers in now. One of the utilities said we need $50 trillion of investments, half of that for renewables out to 2040, I believe. So, it's just a huge investment opportunity now. But as Nick said, you have to be careful as an investor. We want to invest in those renewable companies that if they're building out a solar wind farm, that they've signed PPA's already, Power Purchase Agreements. So, they're not taking on the risk of electricity prices, generation prices. So, the power prices, so extremely important there to know what you're in. And I do think batteries are the next way, right.
The reason that renewables are now so vogue it's combination climate change, but the costs have come down dramatically over the last decade and now makes economic sense in a lot of geographies. And it's even going to make more economic sense as the cost of battery storage comes down, it's come down about 80% over the last decade, expected to continue to decline. If you think about it, if a wind farm or solar farm I should say is generating electricity in the sunshine. And during the day, you could store that energy and use it at night it makes that solar farm even more valuable.
Jenna Dagenhart: And Josh, how are you differentiating opportunities within the public versus private sectors? I understand you recently launched a new fund in this space.
Josh Duitz: We did, it's a closing fund and invest in both public and private infrastructure opportunities. Now, institutional investors for many years have been pouring money into private equity funds, where they're investing in infrastructure. And it hasn't really been an opportunity for retail investors to do so, but this closed end fund now allows retail investors access to the private markets.
So up to 25% of ASGI can invest in private opportunities. Now, in the beginning I was a bit skeptical about it because so much money has flowed into the private markets. What we've seen, I'm assuming Nick has seen the same thing, many times in the private markets where we see assets being sold there and high evaluations in the public side, which really doesn't make sense because generally you would think for an illiquidity it should be a discount, not a premium.
So, on the private side where we've done at Aberdeen Standard is, we really focus on the lower middle market. And a good example of that is something Nick that mentioned earlier is in the water space. In the United States there's 3,300 electric utilities, but there's over 50,000 water utilities. So, we've taken the past opportunity to our private equity team or real assets team within Aberdeen to start buying small water utilities. So, water utilities that might have 5,000 customers to it. And basically, what's happened is it was a real estate developer who developed the plot of land, after they developed it, they sold off those pieces and then left with the water utility. So, if you could buy that, generally you could buy it six to eight times EBITDA, which is a much low evaluation where it trades on the public side, roll it up then you have an attractive infrastructure asset. And then you could even sell off at a high evaluation, hopefully at a certain point.
So, we do see as many opportunities as possible within the private space, but you have to be very selective because of how much money has floated into the private space.
Jenna Dagenhart: And how do you approach those different valuations in public versus private markets?
Josh Duitz: So when we invest in the private market we always want to discount to where the assets are traded in the public markets, because we think if you're investing in an illiquid asset, you want a discount not a premium. And also, when we're looking at, in the public side, we see that assets are trading in private at steep premiums, to where they're trading in the public markets. It gives us even more confidence in our investment thesis that right now is actually a very good time to invest in infrastructure assets within public markets.
Jenna Dagenhart: Nick, are there any infrastructure areas that you're excited about right now that maybe aren't making headlines just yet?
Nick Langley: Yes. So, the listed market, as well as the private market for infrastructure is interesting Jenna in that it's a big market opportunity set over two and a half trillion dollars market capitalization. But when there's flows moving into the space for example, the ESG thematic and how that's playing out in infrastructure, you tend to see mispricings in the market. And the same thing happens in the private markets as Josh has mentioned. They're targeting the mid-market and below for a lot of the larger deals they're becoming very expensive and it's simply the weight of money, capital chasing specific ideas.
And so, what that says to us is as an investor, if you're looking at this space think about doing some work with specialist investors like Josh and I because we're across the market on a global basis and we can take our capital where the opportunities are.
And when you look at what has happened over the last 12 or 18 months, there's been a significant amount of capital follow their ESG thematic into renewable energy. And there are very high growth expectations there, but a lot of that capital has moved out of boring old fossil fuel type companies to the extent that at one stage last year, the markets were pricing the midstream pipeline companies that Josh mentioned earlier on the basis that they would all close down within 10 years.
Well, we're going to need gas and rely on gas as a bridging fuel for at least the next two or three decades. And so, there are opportunities that arise in the markets that really don't hit the headlines that you have the ability to buy into a solid set of underlying assets that have got long-term cashflow generation generally backed by regulation or by contract.
And you can have great confidence that you are going to learn a solid return on that investment over a longer period of time. So, gas is one area that's interesting. Josh has discussed the wireless tower companies and the build out of 5G infrastructure, that is a global phenomenal, there is significant capital that we'll move into that space over time. And it's really gets government and public policy support because governments see it as a way to close the inequality gap within their communities and their countries.
Jenna Dagenhart: Yeah. And I'm glad you bring up 5G because the pandemic has really underpinned our necessity or need for communication. As Josh mentioned earlier, Josh, how are you monitoring developments in 5G and other technological trends?
Josh Duitz: I think that what we're looking at it is the best opportunity still is in the wireless towers and globally the wireless towers. So right now, in the United States, we've had three large independent wireless companies. We've had that around for several years now. But in Europe that's actually just beginning to happen and we're starting to see Cellnex who's become a consolidator of that. Vodafone's going to have an IPO of their wireless towers in addition if you look in emerging markets and similar in Indonesia, we see tower [inaudible 00:39:46] huge discount where they traded in the United States and they still have the population growth, and they're still working on 3G and 4G. So, once we get to 5G, they can even need more towers. So, we think there's a huge opportunity especially as see data growing 30% to 40% per year.
And just as a beginning of when I talked about RIM earlier or Blackberries, we had no idea how we would be using our smartphone. I don't think we understand the different applications that we're going to have for 5G, whether it's autonomous driving cars or remote surgeries, we're going to need a lot more towers and towers are going to have to be densified. So, there's a huge opportunity for wireless towers going forward we believe.
Jenna Dagenhart: And a lot of households, especially in developing markets still don't have access to a personal computer or a cell phone.
Josh Duitz: Correct. And everyone needs that broadband connection now.
Nick Langley: When you think about where that goes over time, the internet of things has been bandied around a lot. And so, you take that household it's not just going to be a personal computer or a cell phone, it's going to be connected refrigerators and other appliances. And that may be to aid online commerce. It may be simply for the maintenance. These things identify a fault and they automatically call a technician out to resolve, or they download a firmware update or whatever the case may be. There are literally thousands of use cases for 5G infrastructure and the connectivity that it provides.
Jenna Dagenhart: And the pandemic has undoubtedly accelerated a lot of these technological trends. Nick, how are you approaching your balance of economically sensitive and defensive infrastructure exposures during the pandemic, especially given all these changing mobility restrictions?
Nick Langley: Yes. Great question. So, we were pretty defensively positioned, which meant we held highways toward the utility companies this time last year. And that was because we felt we were getting later into the business cycle, obviously never foresaw the pandemic. What that allowed us to do though was first of all trade some of our higher quality exposures that fell less as the market corrected into specific names that had fallen a lot. Maybe they were heavily owned by hedge funds and the hedge funds had to get out. So, the stock sold off a lot and that happened to a lot of the US utilities. And so, we did things like we traded out of some of our Canadian utilities, and we bought US utilities at deep discounts. And that was a great trade for the portfolio.
And then we turned our mind to, okay, what does the reopening scenario look like? And what we're able to do then was to actually spend a lot of time talking to other companies and think about how economies would open up over time and where the investment opportunities would arise. And that's because in March of last year, pretty much everything sold off. And the first place we went back to be the toll road companies. And the reason for that was obviously economies went into lockdown, but as they came out of lockdown people were concerned about using public transport and so more and more people drove in their cars. And so, the traffic came back on the toll roads much faster than the market was anticipating. We expect the most toll roads around the world they'll get back to 2019 traffic levels, like 2021 or into 2022. Airports on the other hand, air travel was always going to take a lot longer to come back.
And so, we've been very cautious around the airport space. And ultimately, we won't get back to 2019 traffic levels until sometime between 2023 and 2025. So, there's a long recovery timeframe there. So, what that allowed us to do in the portfolio was a shift from the more defensive positioning, which was in a balanced fund, more than 70% of the portfolio in income-oriented product that was 90% of the portfolio, and selectively take some transport and some GDP risk or that reopening risk in the portfolio. And so, we shifted about 10% or 15% of that waiting in the middle of 2020. And we added an additional 10% in Q4 of 2020. And that's really been a great trade for the portfolio to kind of get exposure to this reopening trade as people start to use the infrastructure again.
Jenna Dagenhart: Josh, how are you approaching the reopening trade?
Josh Duitz: So I think it's quite interesting, right? When we talk about airport traffic recovering, right? What are the risks there? So, to me there's different parts of airport traffic. I think that you'll have the point-to-point traffic, whether it's going on vacation and leisure, I think that's going to recover it in the point of point, meaning if I'm going to visit my parents in another state, I think that should all recover.
Question is how much the business travel recovers. So, we'd prefer airports that have less business travel, because if you could zoom, will there be less business travel? And my guess is probably will be some less business travel, but we think that airports were priced for 0 growth for years and years. So, there were, and there still are opportunities within the airport space, same thing on the roads it depends where you are. I think work from home. How many people are going to work from home in the future? I think traffic will be a little bit less, but I think it's priced on many of the roads for being much less. So, I think that's where the opportunities lie when you see it. We saw that as Nick mentioned, during that 2020 in the energy space where investors were pricing in that midstream pipelines were going to go out of business in a decade or so.
So, I think there's a lot of opportunities and mispricing within the marketplace for it. And right now, I think what you've seen in the utility space, the US utilities specifically have really underperformed recently and that could be an opportunity also.
Jenna Dagenhart: Josh looking forward, where are you seeing the most risks and opportunities in the infrastructure space over the next five to 10 years?
Josh Duitz: I think the two biggest risks, the one I mentioned early, if you see interest rates rising, so interest rates rise without inflation, that's always a risk. And if you get governments change and regulation and you get more populism out there where they don't allow that required to return for investments, that is a risk for infrastructure. So generally, we think it's important to be diversified across sectors, across regions. Extremely important that diversification, because when there's a regulation change it generally comes out of left field and it's important to avoid certain countries. We've avoided Venezuela or Russia, Turkey, because if there's a nationalization, then you're in trouble for an infrastructure act and if you own it as well. So very important that you're comfortable with the regulatory environment and the government in place for it. So, I think those are really big risks for infrastructure at any point in the cycle. So, it's extremely important to do your work and understand those factors.
Jenna Dagenhart: Nick, how are you diversifying and being prepared for various risks that could arise?
Nick Langley: We've diversified the portfolio geographically so across different regions. And as Josh mentioned, your regulatory risk is a key issue for infrastructure. You can't avoid that because it's the nature of the space, but what you can do is diversify that risk by taking exposure to different regulatory regimes and regulatory environments. In the US regulation for the utilities is all state based. So, you can diversify across States and remain within the US or you can move capital into Europe, UK, Asia, Australasia and Latin America. And you can gain exposure to a number of different regulatory regime that are all totally independent. They also work on cycles. So anywhere from one to two years in the US out to four and five and even 10 years in other parts of the world.
So, you've got that ability to diversify your portfolio across geographic regions. Then we also looked at the sector basis. So, I talked before broadly about the defensiveness of the utilities versus the GDP exposure of the more infrastructure companies. There's obviously nuances within that as Josh has pointed out. And so, you have the ability to diversify your portfolio across sectors, to gain more exposure to economies that might be growing or have higher inflation and pick companies that have that inflation pass through and benefit from that higher growth profile. So, exposure to some of the Chinese infrastructure companies as an example. So, there are a range of ways that we can tag exposure to different both macro themes and infrastructure thematic across the globe.
Jenna Dagenhart: And Josh, one of your funds has been around for more than a decade. How has your strategy changed over time? And what does that strategy look like moving forward?
Josh Duitz: I think we're adapting as we see changes within the economy. As I mentioned earlier, we had any extreme underweight utilities historically because of the growth, and we thought we could get better growth elsewhere. Now, we've increased that exposure due to the ability for them to grow through renewables. Same thing on the communication side, we have much more exposure to towers than we ever had in the past because of 5G and probably a little less exposure to transportation. We've always had an underweight to energy, and our underweight is even greater now because of the energy transition going on. So, we haven't invested in MLPs historically because we never liked the capital structure there. So, we stick them on general partners there, the GPs and the Quartz now really. So, we'll continue to have an underweight to energy, but we get that exposure through the renewable side.
So, I think those are the biggest differences over time. And we're going to see how the infrastructure evolves over the next decade. It's changed a lot over the past decade, and it'll continue to change, but even though I'd say it's changed a lot, but really the core is still the same. So, the core infrastructure is still going to be there. We were driving on roads 10 years ago and 50 years ago, my guess is over the next 20 years we'll still be driving on the roads. We'll still be using our utilities; we'll still be using water. We'll still be using our electricity. So really that's a core that infrastructure universe. And that's what we want to continue to invest in.
Jenna Dagenhart: Nick, as we wrap up this panel discussion, any final thoughts on your end?
Nick Langley: Just from an investor perspective I wanted to reiterate the importance of thinking about how this works in your portfolio and what you're looking for to do inside of your portfolio. And as we think about infrastructure, we think about investing in real assets or hard assets that have a long life, 20, 30, 40, 50 years life that are going to generate an appropriate return over that timeframe. And that return being backed by the regulation concession contract or the like and that ensures that we have growing asset bases and therefore growing earnings, growing cash flows, and growing dividends with some level of inflation protection.
Jenna Dagenhart: Josh, anything you'd like to leave our viewers with today?
Josh Duitz: I think the one thing that I failed to mention several times, it's just the monopolistic nature of our assets, but many of the assets that we invest in, it's the only airport in the city or only toll road, or I should say the only road that you can really get to from point to point, it's the only energy or utility company there. So, the monopolistic nature of the company also makes these infrastructure assets so valuable. And I think that's important to know.
Jenna Dagenhart: Well, Josh, Nick, really great to have you. Thank you so much for joining us.
Josh Duitz: Thank you for having me.
Nick Langley: My pleasure.
Jenna Dagenhart: And thank you for watching this infrastructure masterclass. I was joined by Nick Langley, Managing Director and Global Infrastructure Strategies, Portfolio Manager at Clearbridge Investments, and Josh Duitz Portfolio Manager of ASGI at Aberdeen Standard Investments. I'm Jenna Dagenhart with Asset TV.