Q: What is the history of the fund?

In 1986, Martin Cohen and Robert Steers established Cohen & Steers as the first investment company to specialize in listed real estate. The firm is headquartered in New York City, with offices in Seattle, Washington, London, U.K., Hong Kong, China and Tokyo, Japan. 

As of September 2017, the company had $61.5 billion in assets under management. I joined the firm in 2003, while Cohen & Steers Global Infrastructure fund was launched in May 2004. 

Our mutual fund has the longest track record among infrastructure-focused mutual funds on the market. The driving force behind the interest in infrastructure was the recognition that real-asset strategies would be increasingly in demand over time. Investors increasingly diversify away from traditional assets like equities and fixed income to seek more diversification in terms of performance and risk characteristics.

Q: How do you define the asset class?

We focus on the owners and operators of infrastructure asset companies that collect fees for usage. These tend to be regulated businesses, often concession-based or contractual infrastructure companies. If not monopolies, real-asset infrastructure companies often are duopolies or oligopolies. Ultimately, they have the value of the hard assets and their businesses are difficult to replicate. These characteristics lead to predictability of the cash flow. 

The companies that fit that description are utility infrastructure companies, which include electricity, gas, water, or renewable energy, such as solar and wind. We are also interested in telecommunication infrastructure, or cell tower and satellite companies. Within energy infrastructure, we would invest in pipeline processing and storage facilities. Lastly, the transportation infrastructure includes airports, marine ports, toll roads, and railways. 

That universe represents a market of $2.5 trillion. Roughly 90% of the market cap is in the developed markets and only 10% is in the emerging markets.

We avoid infrastructure companies with less or no real-asset component, such as engineering and construction, oil and gas production, materials companies like cement manufacturers. The performance and the cash flow profiles of these companies are very different from what we are looking for. Our strategy is about investing in a real-asset core infrastructure portfolio. The infrastructure service companies tend to be more cyclical businesses and to have much higher beta. They also have higher correlation with the broader equity markets. 

Q: Why should investors consider the real-asset infrastructure companies?

The interest in the asset class is really high, particularly by institutions around the world. Historically, since the inception of our index, returns are in-line with equities as measured by the MSCI World Index, but with 300 basis points lower volatility and, more importantly, significantly lower downside. 

Historically, when the equity markets are down, infrastructure is down only roughly half as much. At a time when equity markets appear to hit all-time highs every day and fixed income offers very little in terms of income and total return, investors look for diversifying the asset classes in their portfolios. That’s really the biggest driver of interest.

Q: What core principles drive your investment philosophy?

The first principle is that we invest in long-duration assets and take a long-term view on ownership of stocks in the portfolio. Second, we recognize that there is an equity wrapper to this asset class, which often creates dislocations and opportunities for active managers to generate value. Stocks get mispriced when the market overreacts to specific situations, so we take an active approach to identifying relative value. 

So, the high-level philosophy is relying on long-term core holdings, but if we see dislocations caused by the equity wrapper around these assets, we would actively shift allocations within the portfolio.

The third philosophical point is that we recognize that infrastructure is a fairly inefficient market. There are very few specialists in the many subsectors of the asset class. For example, there aren’t many experts on European airports out there. Those are typically covered by generalists or analysts of industrials or transportation. So, there is some inefficiency on the market because there are so few specialists that focus on the listed infrastructure asset class.

Q: How do you translate that philosophy into an investment process?

Our process begins with bottom-up fundamental research on the companies, which is done by an experienced and global team. We have a team of nine people, including an analyst in London, who covers European infrastructure, an analyst in Hong Kong, and seven team members in New York, who are portfolio managers or analysts covering the Americas.

We screen the universe for all the companies that we would consider investable, or in other words, the companies that fit our definition of core infrastructure. The bottom-up fundamental research process involves analyzing asset profiles and the regulatory and the political environment, because these companies are typically regulated or, at least, politically influenced businesses. 

We also establish a view on the management track record and determine the financial positioning through building very detailed financial models on an asset-by-asset basis for each company we invest in.

The next stage is portfolio construction, which is a two-step process. First, we use a macro framework to identify which subsectors are most likely to perform well in different macro environments based on the economic, regulatory or credit cycle, etc. Although infrastructure businesses have very similar characteristics, such as cash flow predictability, they are also very different businesses. A marine port substantially differs from a regulated utility, so these two businesses would trade differently in different macro environments. 

We examine that framework weekly, based upon a 12-to-18 month view on a handful of macro drivers. The model helps us to develop a view on subsector exposure and to define our allocations. 

Once we have identified which subsector we want to be exposed to, we use the bottom-up analysts’ work on each company to choose the specific companies within the subsector. Overall, we use the macro framework to determine allocations to each subsector, after which we select the securities to own within each subsector using our bottom-up fundamental work on the companies in our universe. Then it is a matter of ongoing oversight of the portfolios. As stock specific subsector valuations change, we can rotate the portfolio.

Q: What’s the significance of the macro view for your process?

It is an essential part of the processes. Every year the dispersion of returns between the subsectors of infrastructure is at least 30% between the top and bottom performing subsector, while during the financial crisis, it was about 70%. 

At the core, we are bottom-up fundamental analysis stock pickers, but I wouldn’t downplay the importance of the macro overlay in our process. Over the years, about a third of our alpha has come from subsector selection, which is directly tied to that macro overlay. Nevertheless, we focus the vast majority of our time on bottom-up stock selection, and that’s where most of the risk in the portfolio lies. 

We also have the benefit of leaning on a dedicated macro research team, which is a great resource. We come up with our specific framework for infrastructure and the input for that framework, but we have resources at our disposal to help inform our views.

Q: Would you give us an example of an investment to highlight your research process?

One of our favorite themes is U.S. cell tower companies, which are a great representation of core infrastructure, in our view. They lease out space on their towers to wireless carriers under long-term contracts – on average seven to nine years in duration. There are revenue escalators that may not be directly linked to inflation, but typically represent 3% to 4% increases every year. 

We have an analyst in New York who is dedicated to covering the U.S. cell tower companies. He does the bottom-up work on companies building financial models, forecasting cash flow and earnings growth, balance sheet conditions over time, evaluating management, etc. These companies came on the radar as attractive from a fundamental perspective.

Cell towers are less regulated, which is a favorable characteristic. They are commercial infrastructure businesses with the most visible medium-term growth rate of any subsector within infrastructure. So, the cell towers score well within our macro framework, as well in the overall valuation framework among the subsectors.

For each subsector, we have a model that lists all the companies in that global space. That model ranks the cell tower companies based on the two most relevant valuation metrics. The first one is the upside or downside to our net asset value, which is typically driven by discounted cash flow valuations. The second metric is the cash flow multiple relative to the growth rate of adjusted funds from operations. Based on these two metrics, the model screens the most and the least attractive global towers.

The model captures and quantifies all our fundamental views on the companies and the macro conditions that affect them, which are included in our discounted cash flow analysis, and reveals the securities within the tower space that we should own.

Q: Could you cite another example?

Another example would be European airports, where the investment thesis is based on expectations for a rebound in passenger volumes, which would drive growing cash flows. A handful of listed companies in the European airport space had very weak passenger volumes last year largely because of terrorist events. We expected to see a material rebound in terms of passenger volumes to drive performance. 

The second factor, which made the subsector compelling, was related to the private transactions for stakes in airports at 15, 20, or 25 times year-ahead cash flows. At the same time, the European airports were trading at nine times year-ahead cash flows. With more than $150 billion sitting on the sidelines, private funds are paying much higher multiple premiums for these assets than on the listed markets. We believed that this dynamic was unsustainable, and that listed valuations would rise as a result.

European airports indeed performed extremely well in the first-half of the year, recording double-digit growth, and both factors were at work. There was fundamental improvement in year-over-year passenger volumes due to the abnormally low volumes in the previous year. Also, the overarching view that private money continues to focus on a finite number of transactions and private funds are paying extremely high multiples, started to positively affect valuations. Now more investors look at listed infrastructure and private transactions in the airport space have supported a very strong return this year.

Q: Do you think your strategy is affected by an Anglo-centric approach?

When investing in 20 different countries around the world, we can’t have an Anglo-centric focus. We need to be willing to understand the cultural, the regulatory, and the political climate in various parts of the world. That’s especially important in infrastructure, because these are local assets that are heavily affected by regulations and politics. 

As we developed our team, we didn’t just send someone from the New York office to London to look at this universe in Europe, which is largely continental. We actually hired a French national, who speaks four European languages and has 17 years of experience in Europe covering infrastructure companies. She has been with us for seven years. 

Our analyst in Hong Kong is Chinese; she is also not a U.S. or an Australian transplant. She grew up in Shanghai and has been covering Asian infrastructure for 11 years, more than seven of those with us. Her universe includes not only China, but also the Asia-Pacific region. 

We took the approach of hiring people with broader experience in their respective regions. We give them the resources they need for covering their entire universe and the resources to travel to all the markets that they are responsible for.

Q: How is your portfolio constructed? And how important is diversification?

We typically own between 30 and 50 names in the portfolio. We aim for diversification in terms of geography, subsector, and security exposure. We have minimum levels of exposure to each major region of the world.

We have the flexibility to take material underweight and overweight positions in each of the subsectors relative to the benchmark. Our official benchmark is the FTSE 50/50 Global Infrastructure Index. Philosophically, this is a long-term, long-duration, asset-type strategy that looks to outperform inflation, but we recognize that there is an equity wrapper to it and we needed a benchmark that relates to listed equities. The FTSE 50/50 is most representative of the opportunity set in the core infrastructure universe.

We have a limit of 10% on each individual security weight. If the subsector is less than 10% of the index, we can go up to three times the index weight. If it’s greater than 10% of the index, we can be two times the index. We generally expect that 75% or more of the portfolio’s tracking risk will come from security selection. 

Q: How do you define and manage risk?

Risk management involves ongoing and constant review of qualitative and quantitative risks by the portfolio management team, as well as by an independent risk analytics team.

As a firm, we consider risk to be an opportunity in some cases. Some risk has to be taken to drive the returns and the alpha that our investors expect. Those risks need to be managed appropriately in the context of the conviction of our alpha views. 

We believe that macro and micro risks affect the companies in the asset class, because they tend to be more regulated and politically influenced businesses. The biggest risk that we face on a day-to-day basis is managing our views to potential regulatory and political outcomes.

Since we have a global approach, we also face specific risks related to corporate governance or regulatory transparency in different regions of the world. We focus on incorporating those risks into our views on security level, subsector level, and geographic positioning.