Listen as they discuss:

• The risk and return drivers of infrastructure.
• Why Melbourne Airport has been a strong performer despite lockdowns.
• How infrastructure can provide a hedge against eroding revenues.
• Understanding the needs and concerns of advisers around investing in an illiquid asset class.
• Positioning for a rising rate environment.

Transcript

Hello, hello, and welcome to the Relative Return podcast. Maja here. I am the managing editor of advice and distribution here at Momentum Media. So joining me today in the studio is John Julian. He's the managing director and fund manager of Dexus Core Infrastructure Fund. Welcome to the show, John. How are you doing?

Thanks, Maja. I'm very well. It's great to be here.

Great to have you here face to face as well.

So John, before we get sort of stuck into our topic today, do you want to give us a brief overview of yourself and then also Dexus and the specific fund we'll be discussing today?

Certainly. My name is John Julian, as you mentioned, I'm the fund manager of the Dexus Core Infrastructure Fund. I've been working in financial services for, I guess, the best part of 30 years now, originally as a lawyer and then in a range of commercial roles.

15 or so years ago, I moved into the infrastructure space, which was actually almost like a bit of a homecoming because one of my main practice areas as a lawyer was actually advising on infrastructure and PE transactions. And then I've been looking after the Core Infrastructure Fund for the last eight years.

Dexus is a leading Australasian integrated real asset house with a high quality real estate and infrastructure portfolio valued at over $60 billion. They have four decades of expertise in property investing and with the acquisition of the AMP Capital Infrastructure business over 35 years of infrastructure experience.

In terms of our fund, the Dexus Core Infrastructure Fund is designed to provide individual retail investors with well diversified exposure to the infrastructure asset class globally. The fund's actually been around for, I guess, it's 16 years now. And during that time, as you can imagine, it's navigated some pretty turbulent times. Things like the GFC and obviously most recently the COVID pandemic.

We invest in a global portfolio of both unlisted infrastructure assets and listed infrastructure companies, and we provide our investors with exposure to 26 unlisted assets and 93 listed infrastructure companies across a well diversified portfolio.

I suspect many people will be familiar with the number of the assets we invest in with some of our key assets being Melbourne Airport, second busiest airport in Australia, MacArthur Wind Farm in Victoria, which is one of the largest operating wind farms in the Southern Hemisphere, London Luton Airport, fifth largest and fastest growing airport in the UK, and Powerco, which is one of the largest electricity distribution businesses in New Zealand.

Oh, wow. And as you mentioned, there are obviously lots of ups and downs, especially for the infrastructure business and most recently COVID. And now we have some geopolitical tensions, unfortunately.

So can you elaborate a little bit on the investment strategy and objectives of the fund?

Absolutely. So, as I mentioned, the fund is designed to provide retail investors with well diversified global exposure to the infrastructure asset class. In terms of what we're trying to deliver for our investors, there are really four key portfolio objectives.

The first is to deliver equity-like returns, but importantly, with much lower levels of volatility than you traditionally see out of listed equities. Secondly, while we don't see ourselves as a yield fund, we're a total return fund, we do understand that investors tend to like to see a reasonable cash yield out of their infrastructure allocations. And so that being the case, we target an attractive level of cash yield as a component of our overall return.

Thirdly, we look to provide liquidity, and we aim to pay withdrawals within 10 business days and have done that over the whole life of the fund.

And then fourthly, and this is where I think this fund is a little bit unusual, it does provide individual investors with the ability to access high quality institutional grade unlisted infrastructure assets that traditionally have really been the preserve of very large institutional investors, people like Aussie Super Funds, Sovereign Wealth Funds, Global Pension Funds, and the like.

So the fact that the fund allows individual investors to access those assets is quite unusual.

And what would you say sort of sets the fund apart from others in the market? Obviously, Dexus does have quite a bit of competition in the market as well, but you guys are sort of steadily growing. So what sets you apart?

Yeah, well, I think there's a couple of things. One is we are one of the longest standing infrastructure investment teams in the market. We basically started investing in 1988, providing financing for the construction of the Sydney Harbour Tunnel, and we've been a constant participant in the asset class since.

We've got a very well resourced and capable investment team that both originates and transact on new investments, and also has a very hands-on asset management approach for the assets under our stewardship.

And just going back to that exposure to unlisted assets point, I'm actually not aware of any other funds in this market that allow individual investors to get exposure to unlisted infrastructure assets with as little as $10,000. So as you mentioned, it is for retail investors, but it's quite easy for them to, I guess, tap into it with the low exposure, is that right?

That's certainly the intention, yes.

And can you share some of the recent performance highlights or some of the key metrics that showcase the fund's relative return?

Yeah, certainly. So I mentioned that one of our objectives is to deliver equity-like returns, but with lower levels of volatility. And I think over the life of the fund, it's absolutely delivered on that objective. If you compare the annualised since inception returns and volatility of the fund, with the returns and volatility of global equities, Aussie equities, and a range of broader listed infrastructure indices over that same period, in all cases, the fund's delivered returns which are commensurate with those other asset classes, but in each case with significantly lower levels of volatility. And in a nutshell, that's exactly what we're trying to deliver to our investors with this fund.

I think one of the other highlights for me in recent times has actually been the way that a number of our assets that were impacted during COVID have bounced back. We've got a number of assets in our portfolio that didn't skip a beat, but we did have some assets that were impacted. And so they tended to be things like patronage or usage-based assets where the revenues are dependent on the level of usage. So for example, airports and the number of passengers that use them.

And so with those assets during COVID, we saw patronage levels plummet due to border closures and travel restrictions. And as a consequence, we saw some pretty significant valuation write downs at the time. More recently, what we've been seeing is a strong and ongoing recovery in those assets. For our airports, for example, we're back comfortably over 90% of pre-COVID passenger levels, and those numbers are growing fast as airlines continue to deploy more and more capacity to cater to strong demand.

We definitely need them to up their service of customers. Works well for your fund and works well for the rest of us.

But in what other ways would you say that the fund manages risk while obviously enjoying attractive returns?

Yeah, absolutely. I mean, there are a myriad of risks that apply to infrastructure assets. As you would expect, risk identification, mitigation, and the ongoing monitoring and management of risk is absolutely critical for any infrastructure asset. And it's a very key focus area for our team.

As an example, some of the approaches we take is that we generally like to take majority controlling stakes in the assets that we invest in. And this allows us to control and influence the strategic direction of the assets. We can set the strategy and then we can hold the management teams within the assets to account.

We focus our investment activities in OECD countries, which have well-developed legal and regulatory frameworks designed to accommodate the private ownership of infrastructure assets.

In terms of things like operating cashflow risk with growth-related assets, so things like airports, toll roads, seaports, and so on, that are reliant on that patronage or usage level, we require that the asset has to have geographic ascendancy with no competitor of any significance within the assets catchment area.

For regulated assets, so things like electricity transmission and distribution, we look for regulatory environments that offer protections and underpin total returns or revenues.

And then in addition to sort of those, I suppose, higher order risks, if I can put it that way, every infrastructure asset is subject to various operating risks, and the operating risks will change depending on the nature of the asset. So we've long had a strategy in our business of hiring people out of the industries that we invest in. We've got a range of people in our asset management team, for example, that have been very high-level executives in a range of operating infrastructure businesses like airports, regulated utilities, and so on.

And the combination of that deep expertise and also the controlling stakes that I mentioned earlier, puts us in a very good position to really understand the risk profile of an asset and how to best manage those risks.

So you really have a hands-on approach, as you mentioned, you have the experts from those fields and then obviously the controlling stakes, so it's really sort of hands-on?

Absolutely. That's correct.

And diversification is obviously often a key aspect of managing risk in any portfolio. How does your fund approach diversification across different assets or is it sectors?

Yeah, sure. So when I think about diversification in the context of infrastructure, I sort of think of it through two lenses. The first one is a bit of a higher order thing. So I'm thinking about the diversification benefits that infrastructure can bring to a broader portfolio. So infrastructure tends to have a relatively low level of correlation to many other mainstream asset classes. And so what that means is including it in a portfolio can help reduce your overall portfolio risk levels.

But then getting to the nub of the question, one of the things that I think is always really important to keep in mind about infrastructure is that it's a heterogeneous rather than a homogenous asset class. And what I mean by that is that assets which might, for example, look the same on the surface may actually be subject to very different drivers of risk and return.

And it works the other way as well. So you might have assets which on the face of it appear to be quite differentiated, but they can actually be highly correlated because they're impacted by similar factors in terms of their performance. So for example, you might have something like an airport in Australia, a toll road in Europe, and maybe a pipeline in the US. On the face of it, you've got three different sectors, three different geographies, which perhaps suggests a level of diversification. But when you look under the hood and think about what drives the performance of those assets, there may be similar factors. For example, something like movements in oil prices might impact all of those assets.

And so while we certainly don't disregard them, we tend to find that blunter top-down diversification measures by, for example, sector are not the most effective way to build a truly diversified infrastructure portfolio. So we spend a lot of time understanding the assets that we invest in and the drivers of risk and return in those assets, and then how they all come together at a portfolio level.

Yeah, definitely. And could you share an example of how the fund's diversification strategy helped navigate through a specific challenging market period?

Yeah, well, I mean, my mind immediately goes to the recent example of the COVID pandemic. Some of our airports, as I mentioned earlier, were heavily impacted and their performance was poor during the COVID period. But conversely, we've got a very well diversified portfolio and conversely, we had other assets whose performance was strong.

So for example, we've got a number of public private partnership assets, which tend to be social infrastructure assets like schools and hospitals. They offer generally availability based revenue. So it doesn't actually matter how much it gets used, as long as it's available for use, it gets paid, and we tend to be paid by government counterparties. So those assets sailed through COVID without a hitch. I think communications was another sector where, you know, particularly with sort of, you know, lockdowns and things like that, we relied on communications to keep us connected significantly, and they perform well.

So while we did see weakness in some parts of the portfolio in those patronage assets, we did see good performance from other parts of the portfolio in an overall sense, I feel like we kind of did okay.

If you dive down to an asset level, I actually think a good example of diversification at work in the pandemic environment, funnily enough, was Melbourne Airport. So as I mentioned, for extended periods during 2020 and into 2021, we had periods where there was minimal passenger traffic due to those border closures and travel restrictions.

And you can imagine, easily imagine what impact that had on the airport's aeronautical revenues. And also it's other revenues that are correlated to passenger movements. So things like ground transport revenues, retail, duty free, and so on. It's pretty natural to think about airports in terms of the aeronautical side of the business, and that is the most important value driver.

But airports often have other valuable commercial businesses. And in the case of Melbourne Airport, it sits on a huge site, and within that site, it's got a 430 hectare business park zoned for commercial use. That's currently about a third leased or developed, and there's a huge opportunity to continue expanding that for literally for decades to come.

And what we saw during the pandemic was the revenue from the business park, which is a significant and growing part of the overall revenues from Melbourne Airport. Those revenues were largely unimpacted by COVID because they're completely uncorrelated from those passenger movements that I referred to earlier.

And so that allowed the airport to essentially keep the lights on, stay positive throughout the COVID period, notwithstanding the fact for lengthy periods, we had no passengers. And I think that's a great example of within an individual asset, let alone a portfolio, of the benefits that diversification can offer in a challenging environment.

Definitely. And especially given that Melbourne was the city with the longest lockdown on the planet. So that's interesting to hear.

John, obviously we had the COVID pandemic and now we have, you know, we saw inflation rise and we have interest rates going up and they, you know, keep on going up even sort of past what we expected to be a peak. So obviously interest rates and inflation can significantly impact investment decisions. How does the fund strategy account for potential changes in these economic factors?

Yeah. So the performance of infrastructure assets can be impacted by a whole range of factors and clearly interest rates and inflation are extremely topical right now. In terms of inflation, I mean, broadly speaking, many infrastructure assets have their revenues linked to inflation and it will depend on the individual asset. But as a guide, this might be through built-in inflation escalators under the concession or contractual arrangements that apply to the asset. It could be through the regulatory framework that the asset operates in, or it could just be as simple as the asset having pricing power and allowing it to pass those inflation impacts through. So it does vary according to asset type, but broadly speaking, many infrastructure assets actually benefit from having their revenues indexed to inflation, which provides protection against the erosion of those revenues by inflation. In terms of interest rates, I mean, really there are a couple of ways in which rising rates can impact infrastructure assets. The first of which relates to the cost of debt, which clearly can become more expensive as interest rates rise. And if I think about the approach we take, we carefully manage interest rate risk across our portfolio. Generally what we will do is we will hedge the base interest rate on the debt within the assets over the long term, which helps manage the risk of rising rates. And often those hedging arrangements can be very long term. So where we have assets, for example, with a defined life, like a concession asset, which might, for example, have a 30-year life, we've often got the base rate hedged out for the whole of the life of the asset. 

In addition, we have a very active debt management program and as part of that we ensure that the sources and tenor of their debt maturities are well diversified so we don't have, you know, too much refinancing risk at any point in time. And one of the things that I think is very important and often is overlooked is the fact that the regulatory environments that many infrastructure assets operate in actually factor in the cost of debt when setting the service charges the asset is allowed to charge. So the cost of debt is actually allowed for in that way. There may be some sort of timing differences but generally speaking over a cycle the intention is that the way the regulatory framework works is that it will be reflective of the cost of debt at any particular point in time. Okay, so that's an extra sort of a safety bracket as well.

That's correct, yeah. And obviously, John, as we sort of mentioned there's a lot of recent discussion about, you know, the central bank policies and potential inflationary pressures and, you know, what's the RBA going to do next. How has the fund positioned itself to navigate these uncertainties because there's a lot of, obviously, volatility and there's a bit of fear around the potential recession if the RBA keeps hiking and how do you guys sort of prepare yourselves for that?

Yeah, so, I mean, I think about the characteristics of the infrastructure asset class and the nature of the asset class and, if you'll forgive the industry jargon, what we're talking about with infrastructure assets are assets which provide essential services. The services that people have to use every single day, you know, we're talking about electricity, we're talking about airports and even things that are perhaps less front of mind but I think are really important. Things like schools that kids are educated in, hospitals that look after sick people. We all have to use infrastructure multiple times on any given day and so while, you know, sort of macroeconomic factors can influence the performance of infrastructure assets, broadly speaking, they tend to be fairly resilient due to the nature of the essential services that they provide.

Yeah, definitely and John, obviously, at Dexis you have a very close relationship with financial advisors, you know, as a fund manager yourself I'm sure that you sort of work closely with financial advisors. How would you say Dexis maintains transparent communication with financial advisors about the fund's performance and strategy?

Yeah, look, we welcome ongoing interaction with financial advisors that use the fund and certainly encourage them to contact us with any questions. I mean, I actually see a very key part of my role as engaging with the advisors that support the fund for two reasons. One is obviously to support them with their questions but equally I think it's really important for me to understand what's on top of their mind and what their clients are thinking as well. As you'd expect with any sort of investment house, we do provide regular reporting, we provide a fairly detailed monthly report which provides information on the fund performance, updates on the key assets and then we also provide a very detailed quarterly report which delves into those areas in a lot more detail.

We have a very well resourced client services team who are there to support our clients with questions and they work very closely with our portfolio management team to ensure that any client questions are adequately responded to and then our portfolio management team regularly meets with clients either face-to-face or virtually to provide updates on the fund. We also conduct periodic webinars and actually also periodic asset tours where we give clients the opportunity to see and understand firsthand some of the assets that they're investing in.

And it sounds overall, you know, I keep sort of saying you guys are really hands-on but it sounds like you're hands-on on, you know, sort of all aspects of, you know, the managing the fund side of things and then also your work with advisors. Would that be sort of a fair assessment?

Yes, absolutely. It's, I mean, infrastructure assets are, they're assets which we believe require very active hands-on management and we take the same approach in terms of looking after the fund and our interactions with our clients.

That's awesome to hear. Well, thank you so much for joining me on the show today, John.

Thanks, Myra, it's been great to be here.

So that was John Julian, he's the Managing Director and Fund Manager of Dexus Core Infrastructure Fund. Thank you so much for tuning into the podcast today. We do hope you found it insightful and I'll catch you again next time.