From the December 2008 issue of Research Magazine • Subscribe!

December 1, 2008

Tackling Global Infrastructure

Despite a swooning stock market, First Trust has unveiled a new ETF focused on global infrastructure (FLM). PowerShares followed suit and launched the PowerShares Emerging Markets Infrastructure Portfolio (PXR).

According to fund providers, the infrastructure market is poised to benefit from the growth in world population. It is estimated that by 2050, the world population will grow from 7 billion to 50 billion, most of which will be living in cities (by 2050). Companies targeting this growth are involved in engineering, construction, and transportation planning.

Trillions of dollars will have to be spent to build the infrastructure to support this massive expansion. Unfortunately companies can't cash in on projections reaching decades into the future. Existing infrastructure ETFs like IGF and GII are down 40 percent to 45 percent for the year.

At first glance, First Trust's Global Engineering and Construction ETF looks like just another global infrastructure ETF. The iShares S&P Global Infrastructure Fund (IGF) and the SPDR FTSE Macquarie Global Infrastructure 100 Fund (GII) already laid claim on the infrastructure sector in 2007.

Unlike IGF and GII, First Trust's FLM has no exposure to utilities. GII has a 90 percent stake in utilities; IGF has 41 percent tied up in utilities. Utilities are usually considered a defensive sector but have matched declines in the broader market. The Utilities Select Sector SPDR (XLU) has fallen around 30 percent this year.

First Trust's infrastructure portfolio is heavily invested in industrials. This might not necessarily be a benefit as the performance of the Industrial Select Sector SPDRs (XLI) already mirrors the group's performance. Some 95 percent of FLM is tied up in companies like Vinci SA, ACS Actividades and Obayashi. FLM consists of 68 holdings, 54 of which were issued by non-U.S. issuers. The index represents 16 countries (including 24 percent U.S.-based, 22 percent Japan-based and 8 percent France-based).

PowerShares' PXR has a 58 percent allocation to industrials and 36.52 percent to basic materials. China and South Africa represent the largest country holdings (19 percent and 14 percent) followed by Indonesia and the United States with 10 percent each.

First Trust's FLM uses a linear-based capitalization-weighted methodology. The method prevents a few large stocks from dominating the index while allowing smaller companies to adequately influence index performance.

PowerShares' PXR employs a modified market-cap weighted methodology to its 57 holdings. Index components are divided into three segments: large, medium and small-cap. The weight of each segment is determined based on the number of stocks contained in the segment. IGF's top three holdings account for 14.21 percent, GII's top three holdings consume 19.22 percent, PXR's top three holdings make up 12.38 percent while FLM's top three holdings tie up only 8.83 percent.

The First Trust and PowerShares infrastructure ETFs charge annual expenses 0.25 percent more than IGF or GII.

In the long run, the linear or modified market-cap weighted portfolio might provide better diversification with more emphasis on smaller companies. For the immediate future, the entire sector is closely tied to the re-stabilization of the global financial system.

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Ron DeLegge is the San Diego-based editor of www.etfguide.com.

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