A (3:37)

So in this environment of increased inflation risk, the multipolar world with more uncertainty, how should investors position themselves against this framework? And why is private infrastructure so relevant as an asset class?

B (3:51)

Yeah, so I think in the kind of world I just described, you want to be tilting towards three things as an investor. So if we have more underlying inflationary pressure around, you want to more inflation hedge assets in your portfolio. That just makes eminent sense. If we're in a world where GDP growth and the cycle is more volatile, you want asset classes that tilt in a defensive direction to protect you against that. And then I think thirdly, if we're in a world where cyclical growth is a bit more scarce than it used to be, you want to look for structural growth drivers. If you can get asset classes that are exposed to those, that's likely to stand you in good stead over the longer term. And I would argue, Bill, that infrastructure has all of those three traits. So I think that infrastructure is pretty well suited to the current macroeconomic environment that we find ourselves.

A (4:44)

Could you share a quick list of what you think those subsectors within private infrastructure would be the most promising that give defensive and offensive growth opportunities?

B (4:56)

Yeah, so with infrastructure, it's always important to look at it on an asset by asset basis, because some of the sector generalizations, they don't always hold. But with that caveat, what I would say, Bill, is that if you're looking for those three traits that I just mentioned, they're more concentrated in the sort of core, core plus end of the spectrum than they are in the value add end of the infrastructure spectrum. If you're thinking about regulated utilities, they often offer very good protection against inflation. They're often very defensive. So those types of assets I think you should arguably tilt towards in the current environment that we're in. But I would also just flag a couple of other subsectors that I think are pretty interesting and particularly here, I'm talking about from that structural growth perspective. And that is obviously the digital space. There's a tremendous structural trend there in terms of the amount of data growth that is occurring and is likely to occur and how that feeds into demand for underlying digital infrastructure assets. Secondly, things like airports, for example. One of the big determinants of air travel over the longer run is GDP growth and is households getting to middle income status. In short, people love to fly, right? It's sort of a middle income consumption option of choice. And so if we look out over the next 10 or 20 years, there's going to be quite a few countries around the world with large populations that are going to hit middle income status. And that is precisely the point at which air travel demand really takes off, excuse the pun. And so I think the outlook for air travel volumes over the next two or three decades is very good. And that will back up into airports revenues as well.

A (6:39)

That sounds great. Just as an outset, I'd like to get some background of Macquarie that they are widely known as the pioneer in private infrastructure. What's the origin story? How did an Australian investment bank or merchant bank come to develop and train a whole generation of private infrastructure investors?

B (7:00)

We first got involved in infrastructure way back in 1994, actually with the listing of the Hills Motorway road in Sydney. So we were heavily involved in the financing and the listing of that. So Bill, we've been in the asset class for a very long time now and we've been first movers in a range of sectors. But the big picture story around the origin of it I think is really interesting. And that is that in the 1990s in Australia there were a bunch of big picture policy developments going on which kind of created this opportunity. One was that Australia was going through a major privatisation program. After the success of the privatisation program in the UK, Australia was privatizing a lot of assets through the 1990s and into the 2000s, and this included infrastructure assets. And at the same time, legislation was passed in the early 1990s to create a defined contribution pension system. In Australia we call it a superannuation system. But the government wanted to create a private system to get sort of pension liabilities off the government balance sheet, but just to also create a vehicle for people themselves to save and invest for their retirement. So you had two things going on here. One, you had this rapidly growing pool of funds that was looking for long term investments. At the same time you had a bunch of assets coming to market courtesy of privatization that were long duration in nature. So Macquarie saw this opportunity to get in the middle and to match the investment need with the assets that were coming to market. And we got involved in the asset class at that time and since then we've built out some really extensive expertise in a range of subsectors and then we've taken that expertise globally and used it to invest on behalf of our clients and generate what we'd like to think are good risk adjusted returns. And roughly speaking, on the data that we have on returns, there are a few return benchmarks out there, but on the one we follow, average annualized returns since 2004, which is when the benchmark starts, are around about 10%, just give or take depending upon the quarter you measure it from. So sort of roughly in line with the S&P 500, but at a much lower volatility given its defensiveness, the essential service nature of many of the assets.

A (9:22)

Are there also debt investment opportunities?

B (9:25)

There are. You can certainly invest on the debt side in infrastructure and that's been a very rapidly growing area over the last few, five or six years, I would say. And I guess the attractiveness of it relative to perhaps other private debt options that are out there are one, it's defensiveness, as we talked about. Two, the fact that it's asset backed, right? By definition, an infrastructure asset is a real asset. It has a big tangible asset sitting behind it. So that gives you some protection. And then also just in the world we find ourselves now, Bill, with AI, I think infrastructure is likely to be relatively immune to the disruption that AI is causing. Obviously software companies are currently being affected by AI disruption. A toll road is probably not going to be right. A regulated utility, it may even benefit from AI. So I think it's relatively resilient to that wave of disruption that AI is bringing. The point, I would just add here, Bill, it's a lot of people look at infrastructure equity and think that it behaves like debt, that they think it's part of a debt investment bucket, right? So you might start with low risk government bonds, you might move out the credit risk spectrum, you might move out the duration spectrum and then you might get to infrastructure equity on the end of that as sort of high risk debt, as in that's how it behaves. It's really. It's not true. It is equity. It behaves like equity. It does better when the cycle is strong, it performs weaker when the cycle is less strong, relatively well, but still weaker in absolute terms. It is very defensive equity, as I talked about at the start. But infrastructure equity is equity, it's not debt.

A (11:05)

Well, part of the defensive nature is the downside protection because of the hard assets and then the inflation protection. So maybe you could describe how an equity investment can provide those levels of protection.

B (11:20)

Sure. There's mainly three mechanisms through which infrastructure equity provides a hedge against higher inflation. Some infrastructure assets will offer you a straight up real return. Not a lot, but some do. So that obviously provides you with a very good hedge against a higher inflationary environment. Far more common though, is that you'll have a mechanism built in to the asset that you can increase pricing by some formula related to inflation. These mechanisms are often built into many infrastructure assets, and that can come through regulation, as in the government can regulate, that is the formula for your price increases. Or it can come through contractual arrangements with your counterparty. That mechanism will provide you with a really nice hedge, a really good ability to pass on cost increases, maintain margins, and therefore deliver a good real return in a high inflation environment. The last mechanism is really just due to the nature of infrastructure itself. So by definition, one of the attributes of an infrastructure asset is that it's in a monopoly or a monopolistic position within its industry. And so if you're a monopoly or in a monopolistic position, you have pricing power, right? You have that ability to pass on those cost increases to a very significant degree. Now, I would add here that other equity, of course, has inflation hedge attributes as well, whether it be listed equity or private equity companies have some ability to pass on cost increases. It varies by industry, it'll vary by. But what I would say is that within infrastructure, that link between the cost increases and the revenue line is just much tighter. It's much more consistent for a much larger percentage of the market cap than is the case for listed equities and private equity. And that's what makes the difference for infrastructure equity versus other equity. It's an asset class that offers a good hedge against underlying inflationary pressure.

A (13:15)

Daniel, taking a step back in the public markets, we've seen this trend away from asset light models to asset heavy models, capital intensive models. So there's a new term out there, halo heavy asset, low obsolescence, a move toward tangibles such as industrials, and certainly includes infrastructure. What does private infrastructure provide that public infrastructure investments don't? Why not just access the asset class through public ETFs?

B (13:49)

Yeah, it's a good question, Bill. And firstly, if we're talking about listed infrastructure, it depends a bit on which benchmark we're talking about. But in private infrastructure, you're getting a more pure play, infrastructure exposure. So most of those listed benchmarks would include assets that we at Macquarie on the private market side would not consider infrastructure. So for example, you know, if you had an asset that had a significant retail business, that is not really so much infrastructure. If you had an asset that had a lot of commodity price exposure, that's not really infrastructure either. What does that back up into in terms of what you're buying? I would say as a generalization, in the listed space, the infrastructure benchmarks, they will give you some protection against inflation, they will give you some defensiveness, they will give you some exposure to, to structural growth trends, but not as intensely as private infrastructure does, because private infrastructure is a pure play. The inflation protection is stronger, the defensiveness is stronger, and your exposure to those growth trends is higher. That's the difference really.

A (15:00)

We've seen a lot of geopolitical conflict in the last few years. Ukraine and now Iran. We've also have had pandemics. All this has highlighted the need for a reliable supply chain. What are the opportunities here in private infrastructure in terms of traditional infrastructure like transportation and supply chains?

B (15:22)

Yes, we already talked about the airport story, Bill, and the port space is something that is perhaps worth talking about as well, because as I mentioned at the outset, I think we're in a world now where we are de. Globalizing. You know, you would think, okay, if we're deglobalizing, that means slower trade growth, that could mean challenges for ports. And it's certainly true that trade growth going forward, I think is likely to be slower relative to GDP growth than it was through that period of hyper globalization from the fall of the Berlin Wall up until around about 2020 or so. But the good news is this is well recognized in the port space and ports are largely priced for it. So if you look at, for example, the trade GDP growth multiplier, which is the sort of key variable here, year, at points in the last 30 years, that has got up to two times, right? So trade has grown at double the rate of GDP growth. That number almost never goes below one. To go below one, you need events like the 1930s, which started with the Great Depression. There was a recession in sort of 1937. And then of course, we had World War II towards the end of the 30s. So that's what it takes to get below one on that ratio. And if you look at, you know, it'll vary a lot by individual port, but a lot of them at the moment are being underwritten at 1 to 1.25 times on the trade to GDP growth ratio. So you've got to be a little bit discerning, I think, about which port you get exposure to. But, you know, I do think there are some good opportunities there as well, because, you know, we think we're in a bit more of a difficult environment from a trade growth perspective. But it's not going to be anything like the 1930s. And there can be some opportunities there as well. Toll roads are always pretty interesting. They're often driven by real disposable income. That's what drives sort of traffic growth. And there's every possibility that growth in volumes across toll roads is going to remain fairly healthy in the decades to come. So, again, you've got to pick your toll road. But I think across all three of those subclasses within transport, you know, there are interesting opportunities.

A (17:22)

Well, one thing that's really been highlighted, Daniel, with the oil shock, is that there are global choke points. Straits of Hormuz, of course, is one where ports are not accessible. There's others around the world, for example, Suez Canal, Panama Canal, other straits in Asia and Europe. So it seems like there's going to have to be a lot of redundancy built in to assure supply chains to keep the system antifragile, so to speak. With all this redundancy, we're sort of baking in extra cost. It seems like there's just going to inevitably be more inflation. Is that a fair view of the world?

B (18:01)

Yeah, I think that's right, Bill. If you have higher geopolitical risk, these choke points are going to cause you problems more often, which means you need to build redundancy into the system. Absolutely. And as we've talked about, sort of infrastructure offers a good hedge against that underlying inflation. And when you're in a higher inflation environment, it means two things. One, it means there's more underlying inflationary pressure around. Right. Like it bubbles along at a higher level all the time than it used to. But it also means that you have these sort of periodic surges in inflation, like more often. That's just part and parcel of a higher underlying inflationary environment. And this choke points issue, I think, is a perfect example of that which just adds to the volatility of the underlying macroeconomic environment.

A (18:47)

Let's turn to the other big issue of the day, besides geopolitics is really around the opportunities and threats in AI. And we've seen so much growth in data and AI as well. How does Macquarie view the opportunities there? There's been so Much focus on data centers as a great way to access both the surge in demand for data and AI. How do you see that opportunity?

B (19:11)

Just to backtrack for a second. We identified the digitalization and data growth theme quite some time ago as a really attractive theme, something we wanted to get exposure to. And as part of that we bought little data center platforms. And we've then taken both our in house expertise that we had in the space, as well as the expertise from some C suite folks we've worked with to really build out the platforms, right? To grow them, to improve the revenue line of them, inject equity, continue to build out those platforms, and five, six, seven years later, we think we've built up quite a lot of in house expertise on how to do that. Now it's an increasingly competitive space and there are a number of things that you need to be good at. You need to find the right locations that have access to power and have access to water. Increasingly you need to manage local stakeholders. All of those things matter. Also. What matters is like a track record of execution, right? The hyperscalers will work with you if they're confident you can deliver. And if you have a track record of delivering, that really helps in that respect.

A (20:23)

Investment around AI seems to have evolved. Originally, people focused on LLMs on the software side. It now seems to be more around what people sometimes call picks and shovels around the infrastructure, for example. So data centers have really received so much attention in this regard.

B (20:42)

It.

A (20:42)

Is there any concern about this being a bubble with so much attention?

B (20:46)

There's certainly concern we might be in a bubble here. From a macroeconomic point of view, we think we're not yet in a bubble. So what we did was we went and looked at the tech boom in the late 1990s, which was fueled by the Internet and the computer and everything that was going on there. And we pulled apart the national accounts, we pulled out all of the components related to the tech sector, and we looked at what happened to tech investment through the late 1990s and have compared it to the current period. So since ChatGPT was launched, how has tech investment evolved? And in short, we think tech investment has actually grown more slowly this time around than it did in the late 1990s. That may be hard to believe, but that's what the data show. And in fact, at the same point in the boom, we. We're currently about 20, 21% below where we were in the late 1990s. And I would say I think AI is probably a more powerful technology. So it probably justifies investment more. So from a macroeconomic point of view, we certainly take the view that this has quite a way to run yet before we need to get too worried about it. That said, you always want to be paying attention to marginal returns on capital when you have a rapid run up in investment. But overall, we don't think we're in a bubble yet. And then if you look at it on the ground, I would say there are a few things to consider. When people were building out fiber in the late 90s, early 2000s, some of the utilization rates that they were building was like 5%. Now you build a data center and it's almost basically 100% occupied on day one. And what that sort of speaks to is that the supply of the infrastructure just can't keep up with the demand here. Even if the demand was too slow because AI turns down, there's still an underlying need for supply to catch up. As in if where the demand growth issue is 25% or 5%, we're still going to need to build a lot of infrastructure to meet that level of demand. And then lastly I would say the thing to consider is how much volume risk are you taking with a data center? So for example, generally Speaking, you have 15 year leases with some of the world's largest, most credit worthy companies, right? The hyperscalers. So if there is a downturn in AI, it could affect a multiple perhaps that people are willing to pay on data centers. I'm not saying there would be no impact, but from an operational point of view, you are relatively resilient. So yes, people talk about it, yes, investors are worried about it. I think it's right to look at it. But both from a macroeconomic perspective and a sort of bottom up industry perspective, we think they're sort of further to run in terms of the boom. And these assets are pretty well placed even if there was a downturn.

A (23:29)

Thank you, Daniel. With data centers, of course, an issue arises in terms of energy. These data centers are power hungry and often existing power supplies in the developed countries are already maxed out. So often they have to secure their own energy supplies. So could you talk us through the issues on energy, where you see the growth there in terms of power generation and what the opportunities are there?

B (23:56)

Yeah, it's a really good question, Bill. Because the energy space has become increasingly connected to the data and the digital infrastructure space. What we're seeing is that in the US for example, and this broadly applies to the rest of the developed world over the last 20 years or so, energy Demand basically hasn't grown, right. It's kind of been flat. So our economies have grown, GDP has grown, but energy demand hasn't grown. So over that time, we've just become significantly more efficient at our use of energy. But now what we're seeing, courtesy of everything that's going on with AI and data centers, we're seeing a step change in growth in demand for power. Power demand growth is going from essentially 0 to 2 to 3% annually. Now, that may not sound like a lot, but it is because you're going from zero to three. Right. But it's a lot also because supply takes quite some time to bring online. Right. So whether you're building a traditional fossil fuel powered plant or a renewables plant, these things take time to construct. You need approvals, you need grid connections, et cetera. So it does take time to bring that supply online. And, you know, renewables have a role to play. This is the exciting thing because there's so much more demand for power. And if you look at a lot of the hyperscalers and others are just trying to get power wherever they can. And for renewables, you know, they have a significant role to play in terms of providing that power. But just from a fundamental demand supply point of view, you want as much power as you can get your hands on, and renewables offers that. Now, it also offers reasonable energy security. Right. Because it's a domestic source of power. You're not reliant on a foreign country or a foreign government for any of your fuel. You don't have to import anything to run these things. And so in a world where geopolitical risk is higher, and we have these events like we have at the moment in the Middle east, flare up every now and then, we think security of supply is going to be an increasingly important issue. And renewables offer that as well.

A (26:05)

It sounds like this sector is another area where we're going to see more inflation as well. The data centers are driving up demand even on the everyday consumer. They're going to see their electricity rates go up is really going to hit core inflation.

B (26:21)

Yeah, I think we're already seeing that bill. So generally speaking, across the world, power prices have been growing more rapidly than overall inflation. And it is an issue for households and consumers. And if it's an issue for households and consumers, it's an issue for governments as well. And as you know, governments often put in place mechanisms to protect households from excessive price increases within the infrastructure space. We refer to this as the affordability issue. And I think it's Again, it varies a lot by geography, but it is really important, I think, when investing in that area to really understand how this works, right? To understand how governments and politicians react to surging energy power prices, to understand regulatory cycles, to understand how regulators navigate this, how to interact with regulators, to get win win type outcomes, which is of course what everybody wants in all of this. And really a lot of that comes in my opinion is from experience, from having done it many times, from having gone through many regulatory cycles. In some ways, infrastructure assets are quite simple businesses people might say, and in some sense that is true. But if you get into the weeds, they become quite complicated. And I think the ability to navigate these types of pressures is going to be increasingly important going forward. And that only comes with experience, I would say.

A (27:43)

Daniel, we've covered a lot. Last question. Infrastructure has delivered very good risk adjusted returns you've mentioned. Is it too late to get in now? How much is already priced in?

B (27:55)

This is a fascinating question, Bill. So the first thing we looked at is valuations. Are valuations high at the moment or not? And in short, the answer is they're not, right? So they're kind of back now around about their long run average level. And so if you think, okay, over the last 20 years, infrastructure has delivered a great risk adjusted return, valuations are currently around their long run average. That would suggest that valuations are certainly like no barrier to continued good risk adjusted returns. Okay, great. But I guess the next question might be what has been the fundamental driver of that good risk adjusted return delivery and are those factors continuing going forward? We really dug into and tried to unpack from an operational point of view, how has infrastructure performed over the last 20 years and what has driven that performance? In short, what we found was that if you look at the EBITDA growth of infrastructure, it's surprisingly strong. And it's been almost as strong, for example, as the S&P 500, which I would argue is a very good result for infrastructure. Infrastructure is defensive, low beta, a steady growing asset class. That is its appeal in many ways it's that reliability, that consistency, that defensiveness. But for that type of asset class to have delivered almost the same kind of EBITDA growth as the S&P 500, which contains some of the largest, best managed, most dynamic companies in the world, I think that's a remarkably good outcome. And so then what has driven that good earnings performance? I would point to two things. One is good investment plans from asset managers and good delivery on those business plans, operational improvements, and in some areas. There's less scope for that going forward because some assets have been privatized, have been taken off government balance sheets and optimized. But there is still plenty of opportunity to do that, there's no doubt about it. So that tailwind remains. The other big part of it is that infrastructure just has this really sort of high exposure to some very nice and rapidly growing structural trends. We've talked about digitalization and I think that digitalization is probably the most compelling structural growth trend of my working life. AI is a big part of it at the moment, but it's not just AI, right? It's cloud computing, it's driverless cars, robotics, Internet of things, cameras. All of these things consume vast amounts of data. So there's just this suite of technologies coming over the horizon towards us that use gargantuan amounts of data. And so data growth we think is going to remain very, very strong for a long period of time and that's going to continue to generate plenty of opportunities. Secondly, the energy transition, which we've touched on as well, and that transition creates plenty of opportunities and tremendous growth in certain sources of supply or certain technologies. And I think if you know what you're doing in that space, your ability to capture those growth trends is really there. So we think that is an attractive long run trend as well. And then the last one is demographics, which may not be as rapidly growing, but you can project demographics with a high degree of certainty. Infrastructure has ensured just a very high exposure to these three really attractive structural growth trends, digitalization, decarbonization and demographics. And we think that has been a big part of the strong growth in the revenue line and the strong growth in the earnings line that we've seen. We think these trends remain in place, we think they remain powerful. So we think they're going to continue to drive revenue and continue to drive earnings going forward, forward in the infrastructure space.

A (31:38)

Thank you, Daniel. What you said really highlighted how infrastructure isn't just about stability and inflation hedging, but also about positioning portfolios for future structural change. Many thanks, Daniel, for joining us today.

B (31:53)

Thanks very much, Bill. Thanks for having me on. It was great to be with you.

A (31:56)

And that's all for today's episode of Moving Markets the View Beyond. My thanks to Daniel McCormack from Macquarie Asset Management for sharing his insights on private infrastructure. And for more on global markets investing and the trends shaping portfolios worldwide, be sure to follow the podcast. I'm Bill Fong. Thank you for listening. Until next time, the information and opinions expressed in this podcast constitute marketing material and are not the result of independent financial or investment research.

B (32:27)

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