We continue to research the newer products available in the marketplace that have been created as the industry understands more about the different sources of return and risk available. One of those newer investment opportunities is the ability for all market participants to invest in infrastructure throughout the world. This opportunity comes to us through two innovations: 1) infrastructure projects are increasingly being privatized and then listed on global stock exchanges, and 2) transparent, well-diversified, systematic funds are becoming increasingly available in the marketplace.
What Is Infrastructure?
The term infrastructure represents the structures that provide essential services that society needs to function. The first thing that comes to my mind when I hear “infrastructure” is roads, but the space is much bigger than that. Roads, true, but also bridges, airports, sea ports, power plants, pipelines, phone lines, and wireless service towers to name a few. These assets often have very predictable costs, especially the maintenance required, and often have very predictable income.
Source: FlexShares, Northern Trust
I Thought the Government Owned the Roads
While traditionally the government owned the pieces of each country’s infrastructure, a shift has been taking place to privatize more and more of these projects. The McKinsey Global Institute estimates that more than $57 trillion will be needed in the coming years to maintain and update the world’s infrastructure. In the face of that cost, governments, both local and national, are finding it harder and harder to raise taxes or otherwise appropriate funds necessary for infrastructure spending. At the same time, private institutions have recognized the attractive stable income and stable cost characteristics of infrastructure projects. Through partnerships and purchases, the private sector has begun to take on the costs of building and maintenance, which has opened the door for investors to access this asset class.
Why Invest in Infrastructure?
At APCM, we focus on those asset classes that can enhance returns and/or reduce risks in the overall portfolio. Infrastructure has the potential to reduce risk in a portfolio. The income from infrastructure projects and the costs associated with maintenance are highly stable, and predictable going forward. This allows infrastructure companies to return more income to investors through dividends, approximately 4.3% annualized over the last 10 years, than the typical large capitalization equity, approximately 2.2% annualized over the same time period. The stable income and stable costs associated with infrastructure projects are also reflected in lower expected volatility from infrastructure projects than typical equities. Additionally, infrastructure investments provide the portfolio with some protection against inflation eroding purchasing power over the long-term. Because the earnings growth of infrastructure projects is largely driven by inflation, the return on the investment and inflation should at least rise together over the long-term.
How Can One Invest in Infrastructure?
At first, private investment in infrastructure was only available through direct ownership. In this structure, investors needed large investment pools that could be locked up for decades for access to the opportunity and would likely not be able to diversify their investment across multiple projects. Next, private equity funds began to invest in projects. While investment minimums are lower, lock up periods are around 10 years generally, and multiple projects are included, the investment amounts and time horizons are still prohibitive for most investors. Now, as more and more projects are listed on global stock markets, listed infrastructure can be accessed through mutual funds and ETFs. These vehicles have either eliminated or significantly reduced the investment minimum and liquidity problems of the previous vehicles and diversify the exposure across many projects and countries, but still provide many of the benefits of the asset class.
Source: FlexShares, Northern Trust
Infrastructure investments provide exposure to a growing asset class, one that is increasingly becoming privatized and global. Investment is no longer just for the largest investors, or only for one or two projects. Now, investors of all sizes, with the need for liquidity, and with the desire for diversification within the asset class can participate in infrastructure investment. Infrastructure investment could be a beneficial risk reduction tool to further strengthen an optimal, well-diversified investment strategy. We have identified a fund that can produce the portfolio benefits of the asset class and are adding it to our strategic asset allocation across the risk spectrum.
Vinay Sharma, CFA®
Senior Investment Analyst