Investing in Infrastructure Equities for Growth and Income
There is a recent article in Barron’s titled “Buy Infrastructure Stocks for Big Dividends.” Indeed, global infrastructure equities are now yielding around 3.2%, which is about 75% more than the S&P 500 yield of 2%. But relative high dividends are just one of the key reasons to invest in infrastructure, an asset class we added to LNWM portfolios about a year ago, as a strategic long-term holding. As I explained in a recent paper, investing in infrastructure — power plants, water utilities, roads, telecom towers, airports, hospitals, etc. — allows us to play both offense (enhance return) and defense (lower risk).
In the past decade, infrastructure has actually had better return and risk results that the broader equity markets. As noted in the Barron’s article, from 2009 through March 31, 2019, global equities (the MSCI World Index), had an average annualized return of 8.7% and a volatility level (standard deviation) of 13%. By contrast, global infrastructure equities (the FTSE Global Core Infrastructure Index) fared even better, averaging an annualized return of 9.4% and price volatility of just over 10%.
Looking out, outperformance could continue for these reasons:
Offense/Return Potential: McKinsey Global Institute estimates that $49 trillion needs to be spent on infrastructure worldwide before 2030. As countries transition from monetary to fiscal policies to stimulate their economies and increase productivity, this should translate into higher infrastructure spending. Most of that spending is likely come from private investors, since governments with already stretched budgets will not have sufficient resources for massive new investment.
The majority of these investments will be for essential services (i.e. power, roads, telecom, water) that are not as dependent on economic cycles. In fact, there is a limited number of new infrastructure assets worldwide, which private equity firms are competing to invest in, and this has driven up valuations in the private market. Consider that deals are going for 18 to 20 times EBITDA (company earnings before interest, depreciation and amortization charges) vs. 8 to 10 times for the typical business investment. This is why we prefer investing in this asset class through mutual funds invested in publicly traded infrastructure companies around the globe: valuations are better than in the private markets and we believe prospects are just as good.
Defense/Risk Management: Because infrastructure assets tend to have more stable earnings streams over time (i.e. utilities, cell phone towers, toll roads), this tends to cushion them in downward markets. In fact, the market prices of infrastructure assets have had relatively low correlation to stocks, bonds and real estate.
Importance of Due Diligence
At LNWM, we are also very mindful of the risks involved in any investment, including infrastructure. And this is why we do a great deal of due diligence before investing in an infrastructure equity fund. We want to make sure the managers of such funds have a proven record limiting risk as they look globally for the most promising infrastructure investments. The key risk we see are:
Political/Regulatory: Investments in infrastructure can be hurt by changes in how these assets are taxed and regulated. Infrastructure assets have at times been nationalized (taken over by the government) which can dramatically hurt their market value. Additionally, returns may be dampened by onerous new regulations, including a lower cap on service rate increases.
Economic Sensitivity: Certain types of infrastructure, including toll roads and other types of transit, have attractive risk/reward characteristics, but they are not really essential services and could be vulnerable to downturns in the economy.
Potential for Technical/Political Pitfalls: The owners and managers of infrastructure companies must be highly skilled in operating infrastructure projects, which tend to be complex and large in scope. Further, management must also be able to work successfully with local governments.
For more on the role that infrastructure and real assets play in LNWM portfolios, read my paper on this topic.