Infrastructure has long been fertile ground for equity investors - fortunes were made (and lost) in America's railroad boom, for instance. In the past, stock markets were the only way to raise capital for what were seen as highly speculative investments. These days, the involvement of governments and non-governmental organisations (NGOs) has made infrastructure investment less risky - but it's still highly capital-intensive.
Big Fact 1:
According to the Economist Intelligence Unit, the cost of the Sichuan earthquake may be as high as $76bn (£42bn). The Sichuan Academy of Social Sciences estimates that $29bn-$43bn is needed to bring the local economy back to pre-quake levels. The EIU also recently reported that Anhui Conch Cement, the largest Chinese cement company, which currently has no production facilities in western China, announced in May plans to invest $2.15bn over the next three years to meet reconstruction demand, setting up a factory in Sichuan as well as new plants in Chongqing, Gansu, Guizhou and Shaanxi.
Big Fact 2:
Earlier this year a national commission on transport policy claimed that the US federal government would need to invest at least $225bn each year for the next 50 years. In reality, The Economist reported that the US is spending less than 40 per cent of that amount today.
The Big Story: It's election year in the US and, although the two Presidential candidates claim that investing in America's future is high up their agendas, the reality is quite different: debate on moral values, the war in Iraq and homeland security are likely to set the tone. But, at the far more important state level, there's a huge political debate opening up about what to do with America's crumbling infrastructure, not forgetting the huge investment required in new power stations and the country's energy infrastructure. Goldman Sachs, for example, recently noted that the US power sector has seen investment grow by 33 per cent over the past year, spurred by the increases in energy prices. This US debate is a wake up call: investors may get excited by the recent statement that Russia aims to replace all its major roads within the next few decades, but it's business in the developed world that's likely to generate the most secure long-term revenues.
And that's the key about infrastructure - investors love the glamorous growth story of emerging markets infrastructure investment but they forget what attracted investors to this space in the first place, namely solid cash returns and reliable revenues guaranteed by a safe and dependable legal and political framework. Indian power stations might titillate the growth equity crowd but it's likely to be boring returns from new toll roads in Europe or America that will really get investors excited over the long term. Infrastructure 101 is simple: they require high upfront capital commitments, but they also have low operating costs and relatively predictable cash flows and operational risks. As a recent research note from one leading Australian fund management firm noted (the Aussies are big in infrastructure investment), investors like this space because:
• It has a relatively high income yield contribution to total return. Income yields on unlisted infrastructure investments are typically around 5-10 per cent, according to AMP.
• It has a moderate level of volatility, reflecting relatively steady earnings or cash flows and periodic appraisal-based valuations.
• It has a low correlation with bond and equity markets.
Clearly, though, not all the growth will be happening in the boring first, developed world. In another report on the global infrastructure space, Goldman Sachs reckoned that at the high end, in fast-growing and rapidly urbanising countries such as China and Vietnam, you could see annual growth rates of more than 15 per cent in air travel, 8-10 per cent in electricity and technology, and 5 per cent in roads. In already-rich and urban countries, such as Korea and the GCC states, annual growth could run at 1-6 per cent. The investment bank also estimated that China will be the source of one-half to three-quarters of total incremental demand, although its share should decline slightly over the decade while India will be the dominant source of demand outside of China. All in all, Goldman believes that total investment could be on the scale of $4.35 trillion over the decade. Of this, China would account for some $2.7 trillion (60 per cent), India for $620bn (14 per cent), and the N-11 and GCC together for $670m (15 per cent)
Benchmarks:
One widely used index is S&P's Global Infrastructure index. This index has three clusters: energy, transportation and utilities. Utilities make up about 40 per cent of the index, with the top holding German energy giant E.On AG. In the energy segment, there's US giant El Paso Corporation, which owns North America's largest interstate natural-gas pipeline system. The remaining transportation element includes a classic PFI/PPP (as PFI is called in the US) - Abertis Infraestructuras based in Spain, which manages toll roads in Europe and South America as well as airports, parking garages, and TV and radio transmission networks.
S&P doesn't have the index space to itself, though - the Australian financial sector is very active and none more so than Macquarie, a big investment bank that runs its own funds and also offers the Macquarie Global Infrastructure 100. Unlike the S&P index, this benchmark is actually 90 per cent utilities, so you won't get a truly diversified range of companies.
How to access the theme
There's loads of choice. In the ETF space Barclay's iShare's unit boasts a tracker fund that invests in that MacQuarie Global Infrastructure index (ticker is INFR and top holdings include E.On, French giant Suez and Iberdrola while the total expense ratio is 0.65 per cent). iShare also has an emerging markets infrastructure tracker based on a specialist S&P index - the ticker is IEMI, the TER is slightly higher at 0.75 per cent and top holdings include ADRs in Luxemburg-based Tenaris (pipelines and energy services) plus Czech firm Cez and China Merchant Holdings. iShare's rival Deutsche DBX Trackers also has its own Global Infrastructure fund based on the S&P index - ticker is SPGTINTR, total expense ratio is 0.6 per cent and top holdings include E.On again, Abertis and TransCanada Corporation.
Actively managed funds are also making a big impact on this space. One of the newest firms listed on the London market comes from 3i - its global infrastructure fund (3IN) has a mandate to invest in both developed and emerging markets and recently released a very upbeat trading statement. More established players (in the investment trust sector) include HSBC's well regarded Infrastructure fund (HICL), Babcock and Brown PPL (BBPP), and the Utilico Emerging Markets Infrastructure investment trust.
Left-field ideas:
PFI, or PPP, isn't that leftfield. But when investors talk about infrastructure assets in the first world, they tend to forget that the most exciting growth area will be in a space the UK has pioneered, namely public/private finance initiatives. The real big growth market could be the US, where few PPP projects exist, bar the odd project such as the Chicago Skyway. The UK's PFI specialists should do well and investors would do well to keep track of Balfour Beatty, Interserve, Kier Group, McAlpine and the VT Group.
If you can stomach investing overseas you might want to think about a US fund called Macquarie Infrastructure Co. (US code – MIC). This is a really compelling way to buy into the relatively high-growth US PPP space and it invests entirely in US assets, including airplane servicing (such as refuelling and de-icing) at 66 airports, parking lots at 20 airports and natural-gas distribution. The shares listed in December 2004, and have generated annualised returns of nearly 13 per cent, and the current running yield is a princely 11 per cent a year.
Two allied sectors will undoubtedly do well out of this huge growth in spending worldwide - steel companies and cement makers. In the cement space the top bet has to be on giant Cemex group, which has a US listing under CX (and a lowly rating with a PE ratio of just seven times trailing earnings based on a market capitalisation of $20bn). An interesting diversified play on steel could be a US-listed ETF that focuses exclusively on global steel manufacturers - the Van Eck MarketVectors Steel Index fund (SLX) was up 84 per cent last year, is already up 27 per cent this year and boasts a lowly total expense ratio of 0.62 per cent. Top holdings include iron ore companies such as our very own Rio Tinto, Brazilian giant Companhia Vale Do Rio Doce, plus Arcelor Mittal and American steel producer Nucor.
