Building concrete portfolios

Global infrastructure is aging. So over the next two decades, more than US$50 trillion will be invested in this area, according to the OECD.

And, the demand for upgraded public services is increasing in both developed and emerging markets.

In fact, “a lot of infrastructure is being built for the first time in emerging markets, which greatly improves the living standards [and productivity] of those economies,” says Nick Langley, co-founder of RARE Infrastructure in Australia.

Take Chile and Brazil, where new electrical networks are powering more households. In China, a national highway network is moving goods to poorer provinces and boosting the country’s urbanization rate.

Over the next decade, “130 million people—10% of China’s current population—will move to urban centers,” says Raymond Chan, CIO at Hamon Investment Group in Hong Kong. The firm currently favours investing in Asia’s industrial and information technology subsectors.

Langley says the increasing focus on global infrastructure means there are more projects for investors to fund, in both the private and public markets.

For example, there are currently water, electricity, gas, airport and rail projects happening in the UK, Australia and France. As the sector continues to gain traction, educate investors about opportunities (see “Current hot spots,” this page).

Long-term and sustainable returns

Major companies and institutional players have traditionally been the investors in this space, says Langley. But since some governments don’t have the funds to complete projects anymore, they’re increasingly turning to listed markets.

And “with the advent of listed infrastructure as an asset class, [more] people can take part,” he adds (see “Attracting new capital,”).

Current hot spots

• Chile, Brazil (electricity and water)
• Australia (transport [e.g., rail, ports, roads], energy, telecommunications, water)
• Malaysia (rail)
• Thailand, Indonesia (telecommunications)
• China (roads)
• Canada (electric, pipeline, energy)
• UK (water)
• U.S. (rail, telecommunications, electricity)

Also, “the fees and profits collected from assets like toll roads and electrical companies are steady over the long term,” says Langley.

For example, Australian-based toll road company Transurban has returned 15.6% per annum in the past five years. And ITC, an American electricity company, has returned 14.9% over the same period, while Enbridge has achieved 18.7% per annum.

Investment advisor Craig Aucoin, of ValueTrend Wealth Management, a subsidiary of Worldsource Securities, says this is largely due to the type of contracts prevalent in this space.

Businesses managing infrastructure assets negotiate with materials suppliers, agree on set fees and make long-term commitments before building.

This is the case in North America, says Langley, where governments have implemented comprehensive regulations and long-term contractual frameworks. He adds companies in the UK, the Netherlands, Germany, Chile and Brazil also have strong track records, regulations and operating standards.

Langley adds companies in these regions “have predictable revenues and earnings [since] they’re often remunerated based on the size of their assets [rather than] the economic cycle.”

However, Aucoin cautions the overall sector isn’t recession-proof. It will slow during major downturns. Fortunately, utilities stocks are usually reliable investments since people continue to use electricity, gas and water during downturns, says Matt Dell, head of distribution at RARE Infrastructure.

“Also, the returns of these types of assets are quasi-government guaranteed, since regulators decide what companies can earn on their invested capital.”

So this subsector isn’t “exposed to volume risk, [so] the revenues of the assets remain stable even during a recession,” he says.

Another benefit of infrastructure investing is the sector has low correlation to other asset classes. Dell says, “Correlation of 0.75 or higher is statistically significant, and this sector has a correlation of 0.48 to Canadian equities, for example. So for every 100 points that the Canadian market moves, infrastructure will only move by 48 points. It’s a good diversifier.”

Langley notes investors are currently allocating between 5% and 15% of their portfolios to infrastructure assets. He adds clients often seek exposure as part of real asset strategies.

Dell adds, “We currently [favour] user-pay, infrastructure stocks tied to ports, communication [companies], airports and toll roads. We [also] still hold less than half of our portfolio in utilities…they’ll hold up relatively well during episodes of volatility.”

Indexing options

Indices that track global infrastructure performance include:

• Macquarie Global Infrastructure Index (241 companies)
• UBS Global 50/50 Infrastructure and Utilities Index (100 companies)
• S&P Global Infrastructure Index (75 companies)
• Dow Jones Brookfield Global Infrastructure Index (85 companies)
• MSCI World Infrastructure Index (150 companies)

The MSCI World Infrastructure Index and S&P Global infrastructure Index had three-year annual returns of more than 5% as of July 24, 2013. However, they delivered between -1% and -2.5% over the past five years due to the recession.

Capturing the steady income of infrastructure projects is challenging. Dell says, “It’s not one homogeneous sector since the [subsectors] perform differently over economic cycles.” Even assets within the same subsector can become uncorrelated if projects are completed across diverse regulatory regimes.

Langley adds getting exposure via the listed market is still a relatively new phenomenon. The sector forms only about 4%-to-5% of the MSCI World Index, and there’s a lack of specialist knowledge about how it works.

What’s more, there’s little agreement among participants about what constitutes infrastructure investing, so each index has varying allocations. For instance, Macquarie’s primarily targets utilities, while others weight utilities and transportation stocks equally.

Langley says investors should consider actively managing their exposures to the infrastructure sector. He suggests tilting toward defensive utilities during recessions, such as pipelines, electricity and water utility stocks.

Inside an ETF

Infrastructure ETFs may include engineering and construction companies, although if they dominate the fund, the return profile would be similar to that of an industrial firm. The ETF may also include energy and pipeline companies.

He adds as economies start to expand, switch to “GDP-sensitive stocks connected to toll road, airport, rail and port companies. These holdings will provide high earnings and dividend growth. They tend to grow at multiples of GDP.”

An active approach

Say a client’s considering a toll road company. She’d need to know “a toll road company doesn’t own the actual road, or asset,” says Dell.

Instead, “it owns a concession, which is the right to operate the road for…say 50 years. This gives it the right to collect tolls and the obligation to maintain the road.”

He adds this company would “have to upgrade and expand its toll roads when they reach capacity. [And] at the end of the concessions, the roads usually revert to government ownership or the concession may be renewed, usually at a large capital cost.”

Dell suggests investors need to find out when all of a company’s concessions are ending, as well as see the projected cash flows of each asset during those concessions.

“This is relatively easy since tolls are almost always indexed to inflation, and volume growth tends to increase by a factor of GDP,” he says. l.“The company will [also] generally have a capital expenditure plan that projects capital requirements for the next 20 years.”

This type of legwork can be tedious, so another way to get exposure is through firms that actively invest in infrastructure across the globe, such as Brookfield Asset Management, Macquarie, Lazard and Dynamic.

Attracting new capital

Infrastructure projects come with high price tags, say Keith Richards, portfolio manager, and Craig Aucoin, investment advisor at ValueTrend Wealth Management. To complete highways or railways, for example, managing companies must cover the substantial upfront costs of securing labour, land permits and materials.

And “governments simply don’t have the funds,” says Nick Langley of RARE Infrastructure.

They depend on pension funds and major companies to get funding for new, or greenfield projects. And for mature, or brownfield assets, they’re trying to attract international investors.

“There have been large stock sell-downs and IPOs by governments in Chile, France and Australia,” says Langley. For the latter, the government of Queensland sold off the assets of the QR National railway—now known as Aurizon—in 2010. It was then listed on the Australian Securities Exchange.

In similar moves, Chile sold a minority stake in the region’s largest water company in 2011, and France sold part of its stake in a major, French airport business this year.