Transcript
Hello and welcome to The Download. I'm your host, Dave Richardson. And it is time to catch up with one of our favorite guests, Andrew Hay. Andrew, how are you doing today?
Fantastic, Dave. Nice to be speaking to you.
You look fantastic. You look like you had a good rest. Did you get some time off with the family over the holidays? Were you doing anything interesting?
Mostly in our rest and relaxation state in Southwestern Ontario. A few day trips to visit different pools of family. We moved a lot of snow. We got a lot of snow out in the country this Christmas, which I know you got to avoid, you're on the road. But it was just a very nice relaxing break, and the team is really excited about 2025. This has been a great week to be back in the office.
That is fantastic. We're going to get into ultimately why you think 2025 is so exciting in your area of expertise. But as we were talking before we started taping, and you talked about your snow removal, I went, well, wow, is a business like that an opportunity for you in the infrastructure space? And you said no. And one of the big things that we're trying to do here on the podcast. A lot of investors may not even be aware that as a relatively small investor, with $25, you can go walk into a bank branch and invest in some of the incredible things available. A few years ago, this was not something you could do, but now we have access to it through you and your team. So I'm learning this space as well, along with all the listeners. And I said, oh, what about a snow removal company? It seems like you'd set up contracts, you'd get fairly steady income out of that. And if it's done at a scale in a country like Canada, where it snows a whole lot, maybe that's going to generate some good stable income. But you said there's a pretty important distinction between something like that and something that you actually invest in. I think it's a great learning for people who are just getting to know this space and what it's all about.
I think a snow removal company could be infrastructure adjacent. That's a very broad definition of infrastructure. Maybe I'll just pick up two themes on this. When we think about infrastructure, we're looking at core infrastructure, low risk, steady and predictable cash flows. And the way that we get that is with often very large companies. And they're very large because sometimes they're natural monopolies or they're regulated. It only makes sense to have one provider of water in your household or electricity or so on, or telephone or other utilities. And so if you're providing an essential product or service to a large number of people, that tends toward that definition of core infrastructure. Now, snow removal is infrastructure adjacent, certainly. Certainly it's important to have good snow removal at a place like an airport, for example, where you definitely need 100% uptime, or 99% uptime. But I would just clarify the way that we look at infrastructure versus that broadest possible definition. And the other way I would think about the way that we look at infrastructure versus that broadest possible definition, a lot of the time I get asked about projects: do you want to invest in a project that's going to take five years to build something, and you're investing every month and you're monitoring it, and you've got a team of engineers and so on. And we don't. Again, this would be one of the infrastructure-adjacent definitions, but not core infrastructure. What we want to do is we want to buy something that's operating. It's already creating yield for investors, so that's the steady and predictable. So all of these things can be wrapped in the broadest definition of infrastructure. We take a view of core.
And the reason for that, again, is you want, as you say, established, stable, because what you're trying to provide to investors is that asset that's going to generate consistent cash flow income for them and for the pool of investors. And if we can do that over time, it becomes a great diversifier up against stocks and bonds, etc. And hey, who doesn't like it when it's stable and regular and somewhat secure, you can depend on it, that's the essence of one of the reasons why we invest.
I love the way you positioned it between stocks and bonds. The core definition does have a risk profile that seem to be between equities and fixed income. And so depending on your needs as an investor, you can either replace the fixed income in your portfolio with a core infrastructure strategy, which would enhance returns a little bit, but perhaps not change the risk. Or you could replace the equities, which would hopefully keep the returns where they are, but reduce the risk. That's why we selected that strategy. But you're absolutely right to call it some of the other definitions, because that broadest possible definition of infrastructure can include things that have higher risk profiles, like private equity risk profiles.
Yeah. I could pull 25 bucks onto a direct investing platform and buy a stock or buy a share of a stock or a portion of a share of stock. I can go buy a bond. I can go and put it in a savings account. But I can't go and buy an airport or a toll highway. And even if I got to try to get all my friends together to pool that money, we each throw in 25 bucks, we're still not buying a toll highway or an airport. But if you have millions of people or hundreds of thousands of people putting in their investment dollars, then we can pool enough to do some really interesting stuff. And that's what you've been able to bring to the table for investors across Canada.
That ability to invest at scale is very important, to have that platform that allows that investment at scale. And I think infrastructure as an asset class lends itself to a very long-term investment horizon. We want to be measured on a total return basis over years and decades rather than months and quarters. Having that kind of asset class in the private investment hands usually creates that better alignment of need for capital and source of capital.
It's actually big pensions who have been leaders in going into this space over the years. And that's a bit of your background, as we've discussed on your previous appearances. But you know, Andrew, we're up 500% year over year in listeners. We got lots of new listeners. It's always good to reintroduce the topic. The marketing folks tell me it's all because of you.
Well, very kind.
That’s for the increase. But it really is an interesting space. You can add it into other diversified portfolios. Again, just add something that helps with diversification, helps manage volatility, returns, everything you want when you're looking for a new asset to add to your portfolio.
Spot on, Dave.
Look at that. There we go. Let's take a look then. What we're doing is a series of videos with a lot of our top experts to discuss their area of expertise and how 2024 played out, whether it was what you expected, whether it was a good or bad year in relative terms. And then we're going to turn our focus to 2025 and the opportunities that present themselves there. So when you look at 2024 in the infrastructure space, was it a good year, a bad year? Or again, since you're looking at over decades or over long, long periods of time, is that even a reasonable question to ask?
It's a great question to ask. I think the word I would use is «fragmented». Whether you had a good year or a bad year depended on a bunch of different conditions. And I'll lay out some of those conditions that were more likely to tilt towards success. But at the core, because with public markets, you have one clearing price. Everyone had the same experience when they bought a share of a listed company. You knew exactly how that share was priced, and it came with identical terms with you. You bought one share, two shares, 9% of the company. What we look at in the private market space and with infrastructure was, you have different terms attached to the equity that you purchase. And if you purchase 10% of a company instead of 9%, maybe you get a board seat, maybe you get access to more information, maybe you get influence within the company to create that alignment of long-term value creation. So I'd say the infrastructure market was fragmented depending on a few different conditions. Number one for me would be, did you have access to capital? Those parties who had access to capital had their selection of deals, and sometimes they were helping out a situation that wasn't distressed, but it was a little bit stressed because interest rates had been higher than they had been in the past. Those companies with more leverage were perhaps motivated sellers of certain non-core assets within their own portfolios, and there was a good buying opportunity. So condition number one is if you had capital. Condition number two might be if you had a flexible strategy to adjust to the market needs because different sectors had different types of stress within them, whether this was interest rate driven or leverage or geopolitical risks or regulatory risks and so on. So that flexible strategy allowed people to have a very wide investible opportunity set, which was helpful. And then maybe the third thing I would say is the process and execution capabilities to actually execute on what you saw within a short period of time to capture that opportunity. Not too short because you don't want to rush things. You always want to be disciplined and patient and get to the right answer. But those conditions of capital strategy and deal execution capabilities were more likely to get you to better investments. If I were to share a statistic, I was talking to a mid-market infrastructure fund based out of Toronto yesterday, one of the stats they were looking at was how many deals that were announced actually got closed through 2024. And their analysis was about half or slightly under. You had these companies announcing a sale, but for whatever reason, they couldn't transact. That could have been a difference in views and value between buyer and seller, or maybe the buyer didn't show up with capital. We saw a few of those cases in the deals that we were looking at. But at the core, 2024 was similar to what we've been seeing longer term. We tend to invest in about 2% of what we're seeing. We were seeing a lot of deal flow. And that ratio isn't unique or special, but certainly it helps to have that wide investible opportunity set, which is facilitated by capital strategy and deal execution.
Going back to my initial point around me and a few of my buddies, we can't just scrape together enough to buy a major piece of infrastructure. But even if we could. Let's say I happen to start hanging around with some better people who have a little bit more money. Even then, we couldn't really do this because it takes an immense amount of expertise to be involved in these deals or a reputation that you have that expertise and those elements that you talked about to even get access to the opportunity to that deal itself.
When you think about the private infrastructure job itself, what you do has three components. The first is to execute on deals. And I'm going to come back to that because there's a nuance to it that's important and that connects with what you're saying. But basically, do good deals. The second is around asset management and value creation. So once you own a company, what are you doing to create value for your investors? Because this is an active investment strategy. And the third is really around building. It's building the team capability, building the organization capability, building the network of advisors or co-investors that you work with globally. Most of these strategies are global, primarily based on developed markets, but global strategies. So to your point about how do you and your friends find the right deal. That deal execution piece, you really have to have a good origination engine. And there are a lot of strategies out there. You hear some talk about, we've got this many people or boots on the ground or these offices. There are different ways to a differentiated origination strategy, but you're absolutely right, it's so important to be able to leverage your network to see a lot of investment opportunities so that you can be selective in the ones that you're actually going to put in the portfolio.
Yeah, I know in talking to Dan Chornous, who some of our listeners will be familiar with, who's the Chief Investment Officer at RBC Global Asset Management, and he talked about what you need to have in some areas of the investment world. You mentioned the characteristics, which we will come back to because I think it's really important that we go back to your three core things that you needed in 2024, which I assume are also things that you need on an ongoing basis, but were particularly important last year. But the idea that a lot of the best deals are available and presented to people who have a reputation. And so there's actually a small number of people who have all of these different elements that we've been touching on that are going to get the opportunity at the very best of the opportunities that are out there. Which is why, again, your background, your reputation, your team, the breadth of your team is so important in this space. Again, it can't just be me and my buddies. We'd have to do this for a long time and prove our capacity to earn the right to be involved in these deals. We're just not going to get there, whereas you and your team are there in space right.
It's true. And I think there are a bunch of platforms that can really execute well on that. I'll gratefully accept the compliment and the acknowledgement of the strength of the RBC GAM network and the RBC network globally. Maybe a stat that I could throw out that punctuates your point, Dave, would be after about a year and a half of investing with this fund—this is a new fund—we've got exposure to 10 companies around the world. About a quarter of the investment is in the US, a quarter in Canada, a quarter in the UK, and a quarter in Australia. So how do you get that proof point for what is your reach and capability set? Different ways to look at it. Sometimes you want that deep specialization in a narrow sector, a narrow geographical definition. But sometimes you want to be able to look at that global portfolio. Our strategy is one that's meant to bring diversification into a portfolio. So we want to get global access in developed markets. This is something that we look at very carefully when we're screening those deals. Specifically, what does it add to the portfolio on that geographical or that sectoral basis?
And then if we go back to your three things for last year in the fragmented market and where there were opportunities, but not everything was an area you wanted to go into. You needed to have the access to capital. You needed to have the flexibility. You needed to have the ability to close those deals. You've got all those three things, correct?
Our constraint is actually executing. We see so much. We have to be very disciplined at what we're executing on. The point that we're looking forward into 2025 is, without sacrificing quality of investment—because we were very pleased with the fund's performance in 2024—how do we get that velocity into the fund because we see incredible demand in all of the channels of investors for this fund. They just would like to get invested even more, even faster.
And so when you say 2024 was a very good year return-wise, do you evaluate your returns in this space exactly the same way you would think about the returns of a stock or a fixed income portfolio, or is it somewhat different? Are you splicing out? Is it what you've set up for the future, or is it just about the return in that one year? Or is it just the same?
We look at a long-term strategy. We would like to measure our success on a five-year plus base. Three-, five-, ten-year basis. We do get measured every quarter, every year. And I think in the longer term, I think in the first year, our total returns yield plus capital appreciation was just a little in excess of 12%, so we're pleased with that. Our long-term expectation for this asset class would be in that range, but perhaps a little bit lower. So call it 7 to 11%, thereabouts.
Okay. Then what was the fundamental key to driving those good returns in 2024?
A little bit «right place, right time», but being selective and disciplined at the investments that you're going to participate in. And quite often, if you found a situation where the party had to exit for their own reason—it's a perfectly good investment, good company, good asset, but they had their own portfolio construction requirements, maybe they were trying to lighten up on a certain exposure— well, we could be a better buyer, a better owner. And so you end up buying with a little bit of an advantage, a little bit of a tailwind. Probably that day, very, very happy. All of the assets are fundamentally performing to investment case and to plan. It really is that we were able to take advantage of a couple of opportunities where the seller was happy and we as the buyer were also happy.
As you say, the higher interest rates that led into the year—and we didn't see really any significant improvement in rates until the back half of the year—that was a headwind for a lot of these businesses. Now we head into 2025. The anticipation is rates are coming down, but longer-term rates have actually reversed and gone a little bit higher in the latter stages of 2024, early part of 2025. So where does that leave us with your outlook for the area in 2025?
I like that you started the conversation on rates because quite often the private infrastructure investor looks at a 10-year treasury as a base rate from which to start, and then you'd add an equity risk premium on top of that, depending on the level of risk within the company. And I think US 10-years—and the 10-year is picked because it has some duration to it, but it's still short enough to have a lot of liquidity—the US 10-year today is probably still in that 4.5 to 5% range, which is a range that hasn't really been in consistently for 15 years. It's back to what you would expect if you stood back and looked at decades of experience. It's come back into a range where people are probably more comfortable and confident taking a view that it's stabilizing a little bit, and there's not so much free and cheap money. And the free and cheap money that existed over the last 10 or 15 years was a real benefit for developers, was a real benefit for those that had high leverage. And so what we're seeing going forward in 2025 is companies that are high quality, moderate leverage—low leverage or moderate leverage—and usually hedged, too. So there's a bit of a protection with interest rates movements. And so what we're going to be looking for is still building out that balanced portfolio and thinking through not just sectors and geographies, but the underlying value drivers that sit behind each of those investments. But with a view to what's those companies' exposures to things like interest rates and inflation.
Yeah, and we were talking to Eric Lascelles recently, and one of the things that he started talking about, just off the cuff, which is what Eric wanted to do, he started talking about the idea that maybe, just maybe, these longer term rates, 10-year rates, we're not going to see them get down to the levels that we've seen in recent decades, that we may be going into a new regime where longer-term interest rates are a little bit higher than we've come to expect. Not ridiculously high, but a little bit higher. Do you have that same mindset? And does that affect the way you're thinking about the investments that you're going to make in 2025 and even beyond if rates do end up staying higher?
It does. It makes us think about the return that would be required to take on any particular piece of risk. And then we look through the company to its exposures to different types of risks, and we try to price it accordingly. So I think if you were coming out of 2023, one metric that I remember seeing was that the 2023 infrastructure return was in the order of 7%, and 2024 would have been higher than that. And so the returns are tied to those fundamental macroeconomic conditions. But the other condition that I think it's really attached to is it can be attached to geopolitics and regulation and some of those big themes that we've seen. And there's been a lot of turnovers of governments in the last year and more to come in 2025. And when we're faced with those kinds of situations, we're very, very careful to look at the companies that we want to invest in as it relates to their fundamental delivery of their product or service to the customer without regard to any subsidies which could be short-lived in the case of a change of government. So we spend a lot of time looking not just at rates at macro, but also the concepts of economic sustainability of a particular product or service and a drive to efficiency. Are these companies doing the right thing not just for investors, but also for their customers. And so that's a lens that we use to think about. And I think that's going to be incredibly important in 2025, where in the last year, two or three years ago, we would have been talking about decarbonization. Then we talked about decarbonization, but not at the expense of pricing cost, cost of the consumer, not at the expense of resilience of the grid. And those concepts, I think, are now playing out with the phrase of energy security. And so these are some of the themes that we look at that tie that political or regulatory piece into what's the fundamental economic driver of the companies that we want to invest in.
Yeah, we got into that a little bit with Eric as well is the shifting politics. And I know when we were having a lot of the different discussions at the tail end of 2023, early 2024, we were looking at this year where more people were going to go to the ballot box around the world than any year in history. And then how would that play out? And then sure enough, as you said, we saw a tremendous amount of change. So governments changing over. Where voters were making their votes and the types of messages that they were trying to send, or at least the way those messages were interpreted in some areas. And then as we go into 2025, we don't have as much going on that way, but we do have a few more governments that may turn over. And there did seem to be a bit of a change in the tone, as you say, around energy and the way we produce it versus the security of energy. And these are massive, big picture changes in terms of mindset and the mindset of capital and where it might go at a different point in time. And you've got to be there trying to assess this all the time as you're making your investment decisions. And again, your investment decisions are sometimes intended to decades in their lifespan. It's really a challenge. Have you seen in your years a sea change like this just in terms of a viewpoint in a very critical area that's been as quick as this? Again, I don't like to get politics involved on the podcast, but these are things that investment professionals have to be aware of, have to have a sense of, and have to get it right, or at least understand the risks of being wrong versus right. As we say, scenario analysis. But have you seen anything like this in the past in your space?
Yeah, there's maybe a couple of things that I'd react to, Dave, and I love the setup. Also looking past the politics, but understanding that there's politics behind everything. But having said that, and people will say things in the news, but every government in the world also competes for capital. Every government in the world wants foreign direct investment into their country. They want foreigners to invest. And so you can't be too punitive. One of the things that we saw coming out of the GFC, the global financial crisis in 2008, 2009, was that governments around the world needed capital, so they needed to increase their tax base. And some of the things that they tried to do was increase the tax on foreign investors because they'd become deeply unpopular if you do it domestically. But then that dries up the FDI, which dries up investment. And so governments do compete for capital. And so the way that they try to create a good investing environment is to provide predictability over time. So that concept of it's safe to invest here because you've got either a proven track record and an expectation into the future is so important. And so your question about how are we looking at 2025? We do look at, there will be these short-term volatile changes to policy or regulation, but at the core, a lot of these things need to mean revert because there is that need for global competition.
Yeah. You feel it in so many spaces where the pendulum swings and just a sense that in some ways the pendulum got a little bit out there in some areas. As you say, you're starting to get, and you use more technical term, mean reversion, coming back to the mean, which is the pendulum is swinging back towards the middle. But it's interesting, as I talked to a lot of different investment managers, that they all have that same sense that there's been that little bit of a shift. As you say, it's something you need to be aware of, but it's not every element of the way you pull the information together and think about making investments.
It's true. Having that mental model that applies to the company that you're looking at and understanding how it exists within the local and global ecosystem and what its exposure is to foreign suppliers, foreign energy, foreign whatever. But then also that push to national security and what's so important to be able to develop at a national level. And I think one or two of the big themes that we see in infrastructure or in infrastructure efficiency in 2025, 2026, is going to be around energy security while maintaining a decarbonization theme. Energy security so nations can control that need for power. And I know we've talked about this in the past, and I think you went deeper with Marcello, but energy as it's used for generative AI. And generative AI, which has use cases around productivity enhancement. I think that's one of the reasons why that's such an exciting area for people to think about. And so that's certainly infrastructure adjacent. And we can talk about different ways of getting access to that theme, whether it's power generation, whether it's data centers, whether it's fiber. But that's one of the things specifically that we're looking toward that could be a step change function from that concept of mean reversion. What are the nations that are going to see increased productivity? GDP per capita, or whatever, however we're measuring it, because they're making that investment in the infrastructure to support that productivity in the future.
Oh, fantastic. Again, I come back to the fact that this is a Canadian podcast. We've got listeners all around the world, but we primarily have Canadians listening to the podcast. I really hope that Canada is poised to make those investments. It's such a great opportunity for the country. And again, I don't want to get political. I think we're all as Canadians, we want Canada to succeed. Whoever wins whatever election, we just want Canada to succeed. I hope that we have leaders that see this opportunity because we are energy wealthy, and we are extremely well-educated. And if you layer in the right tools to improve Canadian productivity—well, Eric Lascelles would say as an economist, that's the magic formula for Canada—just a little more productivity, and away we go.
I love the way you bring it back together. And let me add one final thing to bring us full circle, Dave. We need someone to clear the snow off our roads so that we can go to work to be productive. But I like the way you tied that together.
That is the basics of good infrastructure and infrastructure related activities and good government as well. So just keeping the streets clean is a function of good government. So Andrew, always interesting catching up with you, and I look forward to having you on several more times in 2025, because it is such an incredible space. And what I hear from listeners after your appearance. It just applies to me because I just listen to you and learn so much. It's a great learning opportunity whenever you're on. So thanks for joining us and all the best in 2025.
Dave, you're very kind. You always ask wonderful questions. Thank you for your time today.