Source: Bloomberg Finance L.P., as of December 30, 2022.
While it is appropriate to think of infrastructure as an asset class, when we look at its subsectors there was a clear differentiation among energy, utilities, telecommunication, and transportation. Aided by the re-opening and the Russian invasion of Ukraine, energy was the top performer, while the “growthier” companies engaged in data infrastructure suffered from reduced valuations. Utilities and transportation offered broadly stable returns. While we think that the performance differential between these two sectors will not be as wide next year, we continue to see the rationale for being overweight energy as valuation remains undemanding and global players seek stable supply from North American energy production.
However, we think that the telecommunications infrastructure companies will be better performers in 2023 as interest rates (likely) stabilize valuation pressure and ongoing growth in data consumption delivers higher earnings and cash flows.
Transportation remains an interesting opportunity, given the ongoing re-opening opportunity (particularly with China adjusting its COVID policies) versus the potential for economic weakness inhibiting travel. We remain overweight toll roads, many of which have recovered to 2019 traffic levels with higher tolls from inflation passthroughs, and underweight European airports which face a variety of regulatory and economic challenges.
Additionally, the opportunity within utilities continues to be growth within renewables, although higher energy prices have produced idiosyncratic regulatory pressures via price caps on tariff passthroughs to utility consumers. We are constructive on this sector, but moderately underweight given better opportunities in other sectors. For investors focused on energy transition opportunities, while our broader infrastructure funds are engaged on this theme, we continue to recommend the CI Global Sustainable Infrastructure Pool (CGRN), which focuses on this theme and recorded a 1.1% return from its inception at the end of September, proving that these assets need not compromise on returns.
Given reasonable valuation, stable competitive environments and returns, as well as inflation protection embedded within the operating and regulatory models, we expect infrastructure allocations to meet or exceed most investors’ goals through 2023.
Real estate outlook
2022 was a challenging year for real estate related equities as sharply higher interest rates, which resulted from elevated inflation levels, weighed on valuations. Most major REIT indexes were down 20-25%, underperforming broader equity markets.
The outlook for 2023 is perhaps a bit cloudier than normal with central banks trying to thread the needle between bringing inflation down without tipping the economy into recession. From a real estate perspective, we have a generally positive outlook based on discounted valuations to net asset value, bond yields which have likely seen their peak, strong balance sheets, and fundamentals that should remain resilient even in a weaker economy.
Real estate looks attractively valued on an absolute basis, as well as a relative basis to broader equity markets. On an absolute basis, U.S. REITs are trading 15-20% below net asset value (compared with a long-term average around parity), which has historically represented a good time to buy the sector. On a relative basis, the broader market as measured by the S&P 500 has historically traded at a modest earnings multiple discount to real estate, whereas it is currently trading at a premium to REIT valuations.