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Emerging Market Infrastructure Needs Highlight Global Opportunities

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The winner of Brazil’s presidential election, shortly headed into a second round between current president Dilma Rousseff and her opponent, Aécio Neves, will have much to do to kick-start the country’s sagging economy. And addressing Brazil’s infrastructure lacuna will be a major part of that mandate.

It’s no secret that among emerging market nations, Brazil has been a laggard when it comes to infrastructure spending and that’s been a big disappointment to investors. Brazil is in dire need of roads, ports, and you-name-it, said Aaron Visse, portfolio manager of the Forward Global Infrastructure Fund, “but infrastructure hasn’t been a particularly strong part of Dilma’s track record. Brazil spends only 1.5% of its GDP on infrastructure compared to the global average of 3.8%.”

Should things change in a new administration – and that would include a better framework and terms for private sector participation in infrastructure projects – then Brazil would throw up some exciting opportunities for investors, given the huge potential it offers.

Overall, though, the development of global infrastructure, both in emerging markets and in the developed world makes for an interesting sector to invest in. Here are three reasons why.

Continued Global Growth

In the emerging markets, there’s only one trend: Urbanization, and that means that infrastructure has to keep pace, Visse said. As incomes continue to rise in many countries, more people will buy cars and roads will be more trafficked, which means new ones must be built.

In the West, many countries need to rebuild waning infrastructure. It’s clear, though, that federal tax budgets are very strained and private sector funds will be needed for new builds and to improve existing infrastructure, said Wilson Magee, Director of Franklin Global Real Estate and Infrastructure Securities team and portfolio manager of Franklin Real Asset Advisors.

Case in point: Last week, the British government modified the funding for a £16 billion power plant in Somerset in order to reduce the burden on tax payers.

“In developed markets, we are going to see the private sector play a far greater role in funding roads, power plants, telecom,” Magee said. “In developing markets, water and waste water investment will be critical. Water related companies are a relatively small part of our listed infrastructure universe, but we expect that it will become much more significant going forward. In Europe, we’re in the early stages of transforming power generation away from coal and Germany in particular needs to do that in a dramatic fashion because they’re closing their nuclear power plants. In China, too, there’s no question that they will have to gradually move away from coal and incorporate cleaner energy sources for power generation.”

More Positive Macro Framework

For the longest time, making any meaningful progress on much needed infrastructure was always India’s Achilles Heel.

Now, that has changed and investors are looking forward to greater opportunities there.

“Prime Minister Modi definitely has the reputation of a reformer and a developer, and a strong track record for successful, regional infrastructure projects,” Visse said. “He should be able to spur more PPPs, and I detect a lot of enthusiasm about India and Modi’s ability to cut through red tape and pull projects over the finish line.” The latest Indian budget does have significant provisions for infrastructure investments. Magee agreed, “and we expect that a larger private investment market will develop in India as a result.”

In other countries such as Indonesia and The Philippines, governments are creating a positive framework for private sector participation in infrastructure projects, Visse said.

“In those countries, investors are receiving a proper amount of return on well structured projects that attract capital and keep it there,” he said.

Strong Returns on Listed Infrastructure Assets

With the upgrades that need to be done in developed nations and the new builds required in the emerging markets, it’s clear that infrastructure is a secular investment theme that will last for a long time.

“The listed infrastructure asset class offers lots of stable cash flow through an economic cycle and tends to have low correlation to other asset classes,” Visse said. Listed infrastructure assets allow every kind of investor, from large institutional investors to small retail investors to participate in the asset class, Magee said, from power plants to airports and toll roads. Broad exposure can be achieved across sectors and within both developed and emerging markets that allows for the construction of robust investment portfolios that can be potentially positioned to respond to varying market cycles, he said.

“Certainly, the return profile for listed infrastructure has been very good, with much better performance over the past 10 years than equities, US and global equities, and with similar volatility,” Magee said. “Infrastructure has also provided diversification benefits due to low historical correlation to U.S. bonds. Also, over the past 10 years, listed infrastructure has delivered one third of total returns from dividends, which have grown in excess of 10% annually. Given the earnings growth prospect for these companies, we expect that between 5% to10% is a reasonable dividend growth projection for many listed infrastructure companies.”