Investment in infrastructure has garnered attention lately. Pension funds have embraced the sector, and countries around the world are building and upgrading everything from roads to pipelines to power grids.
The G20-backed Global Infrastructure Hub, an initiative that recently established Toronto as the centre for its North American operations, estimates that US$94-trillion in infrastructure investments will be needed by 2040 to support economic growth as the world population rises and more people move to urban areas.
For investors seeking to play the infrastructure theme, exchange-traded funds (ETFs) provide an easy way to do so. Investors should examine each fund’s holdings, however, because they can have vastly different industry and country exposures, which can have an unexpected impact on returns.
“Look under the hood,” says Daniel Straus, an ETF analyst with National Bank Financial Inc. “Understand the nature of the companies that are inside the ETF to see if they play into your long-term investment goals or short-term tactical view.”
Pension funds, including the Canada Pension Plan Investment Board, are increasingly investing in infrastructure projects as part of an allocation to alternative assets. It’s a way to diversify away from volatile stock and bond markets and obtain stable and often inflation-linked cash flows, such as in the case of owning toll roads.
Because retail investors don’t have the opportunity to invest directly in projects, owning infrastructure ETFs for the long term may be the next best option, though they will not be uncorrelated with stock markets, he adds.
ETFs can also be used for a shorter-term, tactical play on potential infrastructure spending, he says. Some ambitious plans include China’s Belt and Road Initiative to build infrastructure across Europe and Asia, and U.S. President Donald Trump’s proposed US$200-billion in federal spending, which would likely spur additional investment from states, municipalities and private entities.
The reality, however, is that infrastructure spending by federal and state governments can be “very slow moving” amid budget constraints, so it could take years before companies see an impact on revenue growth, Mr. Straus cautions.
Because infrastructure can involve many industrial sectors, ETFs can own energy, utility, telecommunications and construction companies and/or their suppliers, he says. The problem is that some ETFs overweight certain industries or countries, which could surprise investors.
In Canada, for instance, the BMO Global Infrastructure Index ETF (ZGI-TSX), which is 70 per cent in U.S. stocks, has a 41-per-cent weighting in the utility sector and 38 per cent in energy. The iShares Global Infrastructure ETF (CIF-TSX), which is 60 per cent in U.S. equities, holds 48 per cent in utilities and 24 per cent in capital goods.
ZGI, however, posted a more robust 10.79-per-cent annualized return for five years ending Sept. 30, compared with 5.83 per cent for CIF. The difference is mainly due to ZGI’s higher weighting in the strong U.S. market of recent years, Mr. Straus says. ZGI also has a lower fee of 0.61 per cent, compared with 0.72 per cent for CIF.
Investors who want infrastructure investments to diversify their portfolios should consider cheap, broad-based ETFs, while those preferring a tactical play might opt for a niche-oriented U.S. fund, Mr. Straus suggests.
For example, the Global X U.S. Infrastructure Development ETF (PAVE-BATS), which aims to ride the growth in U.S. infrastructure spending, owns railroads as well as companies involved in construction, engineering, steel production and the making and distribution of construction equipment.
The iShares Emerging Markets Infrastructure ETF (EMIF-Nasdaq) targets 30 of the largest infrastructure stocks in emerging markets, while the KraneShares MSCI One Belt One Road Index ETF (OBOR-NYSE) owns companies that are expected to benefit from China’s Belt and Road initiative.
Todd Rosenbluth, director of ETF and mutual fund research at New York-based CFRA, agrees that there is a compelling long-term case for investing in infrastructure, but “there is also going to be volatility, as with any thematic ETF.”
He prefers the US$2.7-billion iShares Global Infrastructure ETF (IGF-Nasdaq) to play this theme, saying it is less risky because it is about 40 per cent invested in more stable utility stocks. Utility companies are also sensitive to rising interest rates, though, and that has hurt this ETF this year, he notes.
While there is a pressing need for infrastructure spending globally, a problem is that it is dependent on politics, says Mr. Rosenbluth. “U.S. President Trump campaigned on infrastructure investments, but here we are two years later, and there haven’t been any federal programs.”
Infrastructure upgrades can also help a nation stay competitive and boost efficiency as well as productivity, but government spending is “something that is very difficult to forecast,” echoes David Kletz, a Toronto-based portfolio manager and ETF analyst at Forstrong Global Asset Management Inc.
Investors who are interested in playing this theme may want to consider large, broad-based, U.S.-listed infrastructure ETFs whose fees are lower than those of some comparable Canadian peers, Mr. Kletz suggests.
For instance, the SPDR S&P Global Infrastructure ETF (GII-NYSE) charges a fee of 0.40 per cent, while the iShares Global Infrastructure (IGF) ETF’s is 0.47 per cent. Both track the same index, which is 38 per cent invested in the U.S. market.
While Forstrong, which manages ETF portfolios, sees merit in infrastructure investing for the longer term, it does not hold any funds in this space now, he says. “A lot of the exposure through infrastructure ETFs is in the United States, and we are not particularly fond of U.S. equities at this moment,” he adds.
“Transitory factors like tax cuts have pushed earnings up to a very high level, and we think, as those start to fade, so will the broader U.S. equity market. … Because valuations in general are very expensive, we would look for a better entry point.”
Retail investors need to be mindful that what pension funds such as the CPP Investment Board are doing differs from infrastructure ETFs, which is “equity investing – not direct project investing,” he says. “That distinction is extremely important.”