There will be massive spending on infrastructure projects in the next few decades.
Global equity markets have roared back to life since March. But there remain many doubts and uncertainties in the world economy, and these may yet herald a return to the downside volatility that has been so much of a feature of the investment landscape over the last ten years.
Are you sick and tired of this unpredictable roller coaster? Or perhaps unhappy that your dividend income has not kept pace with inflation recently? If so, some pundits are recommending infrastructure investment as a less risky alternative. I disagree with some of their arguments, and will attempt to debunk some of the more outlandish claims. However, I still reckon there's a place for infrastructure investments in most portfolios.
The basic building blocks of an economy
An infrastructure investment has at least two features. First it is asset intensive. Second it has little or no exposure to the economic cycle.
A pure example would be where the government, instead of investing a lump sum building a hospital or school, appoints a company to stump up the initial capital cost in return for giving it an annual payment, guaranteed and index linked for the next twenty or thirty years.
This has obvious attractions for the government and for the contractor, who has an income stream almost as secure as a gilt-edged security. I say 'almost' because they may be performance and quality hurdles which could compromise payments. This infrastructure asset class is usually known as 'social infrastructure'.
A more risky segment of the industry is utilities. In the UK, this would comprise companies operating in water treatment and distribution, electricity distribution, waste processing and, more recently, wind farms.
The final infrastructure asset class is transportation and covers toll roads, road maintenance, rail, airports and ports.
Flawed arguments
The following five investment arguments are usually trotted out for infrastructure investments:
- they are 'defensive' and not exposed to the economic cycle;
- they operate in industries where there are high barriers to new entrants;
- they provide predictable cash flows, and therefore dividends;
- they have an element of inflation linking incorporated in their contracts; and
- they tend to be monopolies, or near monopolies in their region.
As usual, life ain't that simple. Ask anyone who's been exposed to the East Coast rail debacle, where the contract has had to be renationalised because the firm over bid for the franchise. And where there are monopolies, there are usually eagle-eyed regulators breathing down companies' necks.
Furthermore, I may not be the brightest star in the investment firmament, but even I can see that if a company goes on a four-day week in a recession, it's going to use about 20% less electricity, water and telephony.
So I prefer not to pay much attention to these slightly underwhelming arguments and focus instead on the secular growth story. The simple fact is that global infrastructure spending will increase massively over the next twenty or thirty years. And grabbing a piece of that growth is probably attractive even if some of the five arguments above are flawed.
Under investment and new demand
Global spending on infrastructure projects over the next ten years is estimated to be US$22,000bn. Yes that's 22 trillion, or more than 11 times the cost of the global banking bailout. The Organisation for Economic Development (OECD) reckons another US$30,000bn is required by 2030.
Much of the investment will be channeled to the decaying infrastructure of the US. There are similar problems in Europe and South America. But over half of it will be spent in emerging countries, where growth can only be sustained by new roads, railways, airports and ports. China alone is now spending 10% of its GDP on infrastructure.
Traditionally, governments would be the lead investors in this expansion, but that is becoming increasingly challenging given commitments to areas such as health, education and security. The opportunities for the private sector are therefore outstanding.
A selection of funds
For the mainstream investor there are three types of fund available: Investment Trusts, OEICs (Unit Trusts), and ETFs. The investment trusts are, HSBC Infrastructure (LSE: HICL), International Public Partnership Ltd (LSE: INPP) and 3i Infrastructure (LSE: 3IN). My preference is 3i because it currently sits at a discount whereas the other two are on a premium to net asset value. It has also just issued a reasonably positive trading statement for the six months to September 2009.
The OEICs available are, CF Macquarie Global Infrastructure and First State Global Listed Infrastructure. Neither has a very long track record and the dividend yield, at about 3% looks low to me.
Finally for those who like ETFs there are db x-tracker S&P Global Infrastructure (LSE: XSGI) and iShares FTSE/Macquarie Global Infrastructure 100 (LSE: INFR).
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