By Richard Elmslie, RARE Infrastructure
As exchange traded funds (ETFs) expand into new asset classes, U.S. retail investors gain access to more of the opportunities that institutional investors have long enjoyed. One example is listed global infrastructure: publicly-traded securities that invest in the same electricity, water and airport assets as the private equity investors.
The headlines touted around infrastructure in the U.S. have yet to materialize, but the reality is there is already an existing listed infrastructure market, deep and liquid (market cap around $2.5 trillion), creating solid investment opportunities in the U.S. and worldwide.
The infrastructure asset class in an ETF vehicle has many attractive characteristics for investors:
- Solid Income Potential: Over the long term, infrastructure assets have displayed a strong cash flow profile due to the regulatory or contractual frameworks underpinning revenues. In turn, this earnings potential can allow these companies to pay solid and growing dividends.
- Possible Inflation Hedge: Infrastructure involves real assets whose revenues are often tied to inflation. As inflation increases, revenue from inflation managed assets also rise and often remain steady in real terms.
- Defensive Growth Potential: Infrastructure products can help investors seeking growth to manage risk in down markets, yet capture substantial upside when markets rise.
- High Liquidity: Unlike unlisted infrastructure, investors in listed infrastructure can buy or sell at any time.
- Lower Fees & Tax Advantages: Generally, two common benefits of ETF vehicles.
- Lower Market Correlation & Beta: All ETFs can rise and fall with markets, and while correlation from listed infrastructure against global equities has been around 0.6 to 0.8, over the past eleven years, infrastructure portfolios have displayed lower equity market beta during times of economic stress.
- Professional Management: Different types of infrastructure can display highly divergent risk/return profiles at various point in the investment cycle. Investors should consider seeking out experienced specialists who know infrastructure, more than those who manage ETFs.
As a specialist manager, the listed infrastructure companies we invest in must meet three key criteria:
- The assets a company owns must be hard and physical (roads, railways, airports, water).
- These hard assets must provide essential services to society or an economy.
- Robust frameworks with the goal of paying the company’s equity holders. These frameworks can be regulatory in nature, or based on long-term concessional contracts. Both structures provide visibility over the company’s ability to generate cash flow.
We look for companies with solid and predictable cash flows. Most of the companies we hold are either regulated utilities or owners of long-term concessional assets. We do not like surprises.
This asset class is increasingly appealing to investors seeking solid, long-term, inflation-linked absolute returns. The weight of funds flowing into this relatively young asset class has grown dramatically: U.S. retail investment in infrastructure is gaining traction.
How attractive can infrastructure ETFs be going forward? Global demand for infrastructure is poised to accelerate over the next decade or so, in both developed and developing markets:
- In advanced economies, infrastructure asset investment is projected to almost double, to more than $50 trillion over the next 15 years, to meet maintenance, capacity and upgrade needs.
- Emerging market economy infrastructure assets are expected to almost triple – to more than $60 trillion over the next 20 years– due to population growth and urbanization.
- Over the past 15 years, for every 1 percent of GDP spent on infrastructure, societies potentially get back about 1.2 percent in additional growth over time. Economies want, and need, this stimulus.
- Increasingly tight government budgets globally should lead to more private sector roles in providing these essential services going forward. Private financing is ready, and waiting.
Much has been made of President Donald J. Trump’s promise to invest $1 trillion on U.S. infrastructure projects, one of the few ideas that enjoys bipartisan support with Congress. This could create momentous governmental stimulus and spur GDP growth. It could also lead to more opportunities to deploy pent-up private capital for U.S. infrastructure investment, but it likely will be at least a year before private equity and debt investors can engage. If successful, this should lead to many other investment opportunities over the next 10 years.
Related: Are Infrastructure ETFs Still a Good Investing Idea?
Regardless of the pace of political developments, we suggest retail investors consider focusing on the potential benefits that a global listed infrastructure ETF allocation can give their portfolios, now: potential solid income and growth, diversification, inflation management and lower volatility, all combined with the lower costs and tax advantages of ETFs.
Richard Elmslie is Co-Chief Executive and Co-Chief Investment Officer at RARE Infrastructure, a Legg Mason affiliate. His opinions are not meant to be viewed as investment advice or a solicitation for investment.