After decades of neglect, the need to ramp up spending on infrastructure is coming to the forefront as aging power plants, highways and bridges have driven interest in new investment. Increasingly, institutional investors such as pension and sovereign wealth funds have been allocating assets to infrastructure. This has helped pave the way for retail or individual investors to invest in and reap the benefits of the asset class. Therefore, advisors should be able to discuss the area with their clients.
Infrastructure assets are mission-critical capital projects that move people, energy, goods and data, earning fees for their use through contracts and concessions. These projects include bridges and toll roads, airports, pipelines and utilities, as well as now, wireless towers, data centers and health care facilities.
Growing Global Need
During the past 30 years, the infrastructure asset class has evolved as many state-owned infrastructure projects have been privatized into investments for institutional and retail investors. This has been largely driven by an ideological shift toward shrinking the size of government and improving labor productivity. In addition, virtually every major city around the globe has been facing the financial challenges created by their constituents demanding maintenance of public services, but resisting increases in taxes to fund or improve them.
According to the McKinsey Global Institute, the world is in dire need of new infrastructure with an estimated cost of $57 trillion over the next 15 years. Given the effects of the global recession from 2009 to 2014, many economies have not responded to the challenge. During this time, spending on infrastructure decreased by approximately 25% in the United States.
The United Kingdom and the Eurozone were similar. Even some countries, such as India and South Africa, which have been increasing overall infrastructure spending, are seeing gaps between the actual and the required investment.
Unique Benefits And Risks
The characteristics of an infrastructure asset provide a compelling investment different than other real assets or equities in general. Infrastructure projects are usually large, long in duration and capital-intensive, creating high barriers to entry for competition.
As crucial services, they tend to have inelastic demand with regulated pricing, creating fairly predictable revenue streams that typically provide stable and reliable cash flows. Select investors have long sought the unique characteristics of infrastructure to diversify their equity risk exposure, generate income and hedge against long-term inflation.
There are also unique risks associated with infrastructure assets, including regulatory, political and natural disaster risk. To mitigate these risks, diversification is paramount. Advisors should examine the makeup of a fund in terms of geography (economic segment, region, country), revenue type (regulated, demand, patronage), and sub-sector concentration (broader representation is better).
Today, infrastructure assets increasingly have been made available through listed equity markets. Some public entities even are available for investment as common stock, such as Sydney, Australia’s airport and seaports in Shenzhen, China and South America.
ETFs are one simple way to access infrastructure investments. A bottom-up approach may be advantageous because it: 1) targets portions of the asset class in greater breadth due to its focus on sub-sector classifications that are impossible to carve out, like wireless towers, and 2) offers broader diversification by going beyond energy, utilities and transportation to include communications and social infrastructure.
Note: Before investing, carefully consider ETF investment objectives, risks, charges and expenses. This and other information are in the prospectus and are in a summary prospectus. Read the prospectus carefully before you invest.
Christopher Huemmer, CFA, is senior investment strategist of FlexShares ETFs. For disclosure details, please visit www.flexshares.com/funds/NFRA.