Infrastructure – rising rates and the "natural hedge"
Inflation has accelerated globally as a result of consumer demand, fuelled by fiscal policy, pushing into supply constraints due to COVID-19 and geopolitical upheaval. US inflation is running at 40-year highs and other advanced economies are at or near similar extremes.
Higher interest rates have traditionally been viewed as a negative for the performance of long-duration investments, like infrastructure, as they put downward pressure on asset valuations. This occurs not only because of the potential increase in the cost of borrowed capital, but also because the discount rate that is used to value infrastructure asset cash flows is likely to increase in response to changes in the relevant long term sovereign bond rate (known as “the risk-free rate”).
While this is true, one could believe the positive linkages that some infrastructure assets have to inflation and economic growth can provide a natural hedge that may be sufficient to offset these negative valuation impacts.