A veteran stockbroker once warned me not to get too bearish at the bottom. That is, to not to be swayed by current bad news and overlook good news ahead.
I always think of his advice when I become bearish on the market. My investment style is to hunt for out-of-favour sectors and stocks and invest against the trend. So, I’m often bullish on stocks when others are bearish and vice versa.
In the past few months, I’ve become more bearish on the Australian share market, despite the prospect of good news ahead: interest rate cuts, probably in early 2025. The market, however, continues to underestimate the remaining inflation challenge or the prospect of the Reserve Bank tapping the brakes again on the economy, through rate rises.
To recap, I’m mildly bearish on the market in the short-term (0-1 years) and bullish in the medium term (1-3 years). Put another way, I think the next six months or so will be difficult for shares because of uncertainty over the inflation/rate outlook.
One need only consider the divergent views this week on inflation between Treasury and the RBA. Treasury thinks the inflation battle will be won by this Christmas; the RBA thinks it take until later in 2025 to get inflation under control. Rarely have these inflation forecasts been so far apart. This week’s Federal Budget won’t help on the inflation front due to its heavy spending.
My view? I favour the RBA’s take on inflation, having previously argued that higher inflation will be more persistent than markets expect. I never rely on Treasury forecasts, given they are not independent of government.
As an aside, divergence between the RBA and Treasury again shows why investors should avoid macroeconomic ‘noise’ and focus on what matters most: company valuations. Macroeconomic forecasts can be dangerously wrong.
The good news is this uncertainty will lead to heightened volatility in share prices in this seasonally weak period for equities (after May). There will be more opportunities to buy companies at lower prices, and to position for a stronger equities market in the fourth quarter of 2025 as expectations of rate cuts build.
Earlier this month, I outlined the case to add a more defensive posture to portfolios over the next six months by building a higher cash allocation. The goal: to have more cash on the sidelines to deploy during market volatility.
There will, of course, be buying opportunities within that volatility. In last week’s column, I argued that there could be a spike in small-cap takeovers, as larger companies look to grow by acquisition in a sluggish economy.
This week’s column continues the defensive theme, this time in global infrastructure assets. Infrastructure is always a useful asset class for long-term and income-focussed investors, and especially so now in a higher-inflation environment.
Several infrastructure funds have underperformed the market, despite core infrastructure in utilities, transport and other areas providing reliable defensive revenue. People still need to use electricity, gas, water and other utilities – and use toll roads to get to work – regardless of economic conditions.
Core infrastructure often provides inflation-linked revenue. Governments allow some core infrastructure owners to pass on higher inflation to consumers through higher service charges, making these assets a hedge against rising inflation.
I like infrastructure for a few reasons. First, as inflation remains ‘sticky’, or even starts to rise again, core infrastructure provides some protection. Second, if the Australian economy slows faster than expected, due to interest rates rising rather than falling in late 2024, infrastructure again has that defensive element.
Third, as rates are cut next year, infrastructure and other interest-rate-sensitive stocks should perform better. The FTSE Developed Core Infrastructure Index (100% hedged to AUD) has returned only 0.4% annually over three years, and 2.8% over five years to end-April 2024, FTSE Russell data shows.
After negative returns in 2022 and 2023, and a barely positive return in 2024 year-to-date, I’m betting on global core infrastructure to deliver better returns over the next 12 months, as the asset class looks to global rate cuts in 2025.
Index ETFs are a useful tool to gain exposure to global infrastructure via ASX. Here are two ETFs to consider:
- VanEck FTSE Global Infrastructure Hedged ETF (ASX: IFRA)
IFRA is the largest infrastructure ETF on ASX by size, with $848 million of assets at end-April 2024, ASX data shows.
The ETF only holds infrastructure stocks in developed countries that earn at least 65% of their revenue from core infrastructure activities. At end-April 2024, IFRA held 133 global and local infrastructure stocks.
By sector, IFRA is 50% weighted to utilities companies, 30% to transport assets and 20% to pipeline and other assets. No infrastructure stock can have a weighting greater than 5% in IFRA.
IFRA’s top 10 holdings include some the world’s great infrastructure stocks. Australia’s Transurban Group, a toll-road operator, is the third largest holding. By country, about 58% of IFRA is invested in US infrastructure stocks.
IFRA has an annualised return of 1.19% over three years and 2.07% over five years to end-April 2024. That won’t please current holders of the ETF, but prospective investors could buy into IFRA after a long period of underperformance relative to global equity markets.
At end-April 2024, IFRA traded on an average Price Earnings (PE) multiple of about 15 times and a price-to-book ratio of 1.8 times. That valuation does not seem demanding for exposure to many of the world’s top infrastructure stocks.
Bought and sold like a share on ASX, IFRA’s annual fee is 0.2%.
Chart 1: VanEck FTSE Global Infrastructure Hedged ETF
Source: Google Finance
- Vanguard Global Infrastructure Index ETF
VBLD, previously my preferred infrastructure ETF, has featured in this column a few times this decade. VBLD has outperformed comparable ETFs over three years.
VBLD differs from IFRA in two main ways. First unlike IFRA, VBLD is not hedged against currency movements, meaning it has currency risk for investors.
Second, VBLD is a straight index fund. Unlike IFRA, it does not cap infrastructure sector exposure or have rules about how much income must be derived from core infrastructure activities to be included its underlying index.
VBLD has returned 5.9% over three years and 4.9% over five years to end-April 2024. That’s better than other comparable infrastructure ETFs over that period, in part due to the lack of currency hedging. Since inception in 2018, VBLD has returned a respective annualised 6.7%, through investments in lower-risk assets.
There’s not much difference between VBLD and IFRA in terms of the number of holdings or average valuations. Much depends on one’s view on the Australia dollar’s direction and whether hedged or unhedged ETFs are required.
I expect the Australian dollar to rise gradually this year as we take longer to cut interest rates, compared to the US, which lifted rates earlier and more aggressively. If I’m right, a hedged infrastructure ETF makes sense.
I also like how fully or partially hedged ETFs remove all or part of the currency risk, allowing investors to gain pure exposure to their view on infrastructure, without having to worry about currency gyrations.
IFRA’s 0.2% management fee also compares favourably to VBLD’s 0.47%. Having underperformed VBLD over the past few years, I favour IFRA for low-cost, long-term exposure to defensive, core infrastructure assets.
Chart 2: Vanguard Global Infrastructure Index ETF
Source: Google Finance
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 15 May 2024.
