Many investment experts agree that infrastructure is a very lucrative area for investment. This applies not only inside America and other developed countries, but in the developing countries as well.
For example, the number of car owners in China is expected to increase as the country moves toward industrialization and wages rise. This is great news for automobile manufacturers, but for many private individuals and institutions, the real investment opportunity may be presented by the infrastructure that accompanies this extraordinary wave of mobilization. Railways, streets, power stations and waste disposal are essential in order to maintain the economic momentum in developing countries. Read on for a look at infrastructure investments and how you can use them to build big profits in your portfolio.
The Developing and Developed World
In America and Europe, the older infrastructure is continually becoming rundown, requiring repair and replacement. This depreciation leads to billions of dollars spent on upgrading and maintaining this infrastructure. Tim Albrecht of DWS Funds in Europe explains "we are facing a unique historic situation. Both developed and developing countries will need to extend or revamp their infrastructures". This is going to cost big money.
Nowhere in the world can the public sector finance this alone. It needs investors - and lots of them. What makes it all so appealing is that the earnings are relatively independent of short-term stock market trends and are also calculable.
The collapse of the Interstate 35W bridge in Minneapolis, Minn. in August 2007 suggests the need to address the issue of aging infrastructure. This is an issue, at least to some extent, in many areas of the world; Booz Allen Hamilton, a technology consulting firm, has predicted that the cost of refurbishing, extending or building roadways, power and water facilities (and other infrastructural necessities) will be around $40 billion on a global basis from 2007 to 2032.
Governments looking to improve local infrastructure will have to seek financing for major projects form large scale contracts with suppliers, engineers and contractors.
A Closer Look at the Nature of Infrastructure Assets
Infrastructure assets generally have high development costs and long lives. This means that they are generally managed and financed on a long-term basis. In the past, infrastructure was generally funded and managed by governments. Recently, this role has been declining and there is more privatization and private funding. This process has opened up the field for private investors.
Infrastructure originally referred to the sewer systems and other parts of a city's most basic framework. Currently, however, pipelines, power stations and all manner of transport routes and carriers form part of the national and global infrastructure. As a result, investment funds that specialize in this area hold stocks covering a wide range of industries and sectors. The risks tend to be well-diversified and attractive to private investors. Institutional investors have also started putting money in this areas. For example, the American pension fund CalPERS announced a plan in November 2007 to shift up to $2.5 billion to a new infrastructure program focused on investments in new roads, bridges, ports and water systems.
There are two main types of risk. First, there are asset-specific risks relating to the design, construction and operation of the particular infrastructure assets. For example, during the construction phase, something can go wrong technically, mechanically or in terms of budget and deadline commitments. The impact on the investor could range from returns that are lower than expected, to bankruptcy in the most extreme cases.
A second type of risk relates to the asset class in general. The market can create problems through unanticipated and disadvantageous changes in demand or supply. A rise in interest rates can also have serious negative effects. For foreign investments, there is always the danger of adverse political developments and exchange rate fluctuations. In addition, infrastructure is often regulated by the government, which could also change and affect the outcome for investors.
Partly because of regulation, infrastructure investments tend to yield fairly low-growth income streams. Such regulation constrains the operation of projects and may have a negative effect on profitability. To compensate for this, the investments tend to be higher yielding than equity investments. The result of these two factors is a general trend of lower price volatility than equity investments over the longer term. Many such investments are therefore regarded as defensive, in that they should provide a steady return throughout the investment cycle.
However, it is important to emphasize that the nature of the underlying asset remains important and the level of risk may still vary considerably as a result. This can be compounded in a relatively risky macro environment outside the developed world. Therefore, some (but fortunately, not all) infrastructure investments are only for adventurous, risk-loving investors. (For more information on risk, see Determining Risk And The Risk Pyramid and Personalizing Risk Tolerance.)
There are also other factors that can make infrastructure investments fairly complex, such as a lack of historical data. Especially in the developing world, various elements of infrastructure investments are quite new. The level of available information is then not comparable with that in industrialized countries. However, given that this could also be said about many other asset classes, this should not put investors off.
What investment vehicles are available?
There are various ways to invest in infrastructure. The alternatives range from diversified multi-asset funds with a proportion of their assets in infrastructure holdings, to dedicated infrastructure funds, to stocks in individual projects. Various forms of debt instruments are also available.
In addition to open-end mutual funds, there are also closed-end infrastructure funds. For example, global investment firms such as ABN AMRO and The Carlyle Group, both of which have American operations, are in the market for such investments.
The average person may already have some exposure to infrastructure investments through large pension funds. For example, in Canada the Ontario Municipal Employees Retirement System created the Borealis Infrastructure Trust to invest in infrastructure.
The Macquarie Infrastructure Company, the world's leader in infrastructure investments, operates in the U.S. and offers a number of different funds and investment vehicles, some listed and some unlisted.
Index funds and exchange-traded funds (ETFs) are also a possibility in the infrastructure area. As in the case with equity index funds, which benchmark the S&P or similar indexes, these are also relatively cost effective. Furthermore, there are ETFs that either track or use the S&P Global Infrastructure Index as a benchmark, which can be a simple method for the average investor to get a liquid position in infrastructure. (To learn more about ETFs and index funds, see ETFs Vs Index Funds: Quantifying The Differences and Benchmark Your Returns With Indexes.)
And then there are high-risk variants that invest mainly or even entirely in emerging markets, such as those in Asia. A lot of money can be made there, but be aware of correspondingly higher risks.
Infrastructure investments have been historically lucrative. However, the past is no certain guide to the future, and there are critics who warn of bubbles and too much money chasing too few projects. Nonetheless, there can be no doubt that the right projects are still highly viable, attractive investments and will remain so.
Infrastructure in Your Portfolio
With the generally promising outlook for infrastructure in the ensuing years, it would seem sensible to consider placing a certain proportion of your funds in this sector. Depending on the structure of your portfolio, risk preference and subjective attitude toward infrastructure, 5-10% of your total funds may make sense.
As indicated above, the risk scenario for infrastructure investments is somewhat mixed, but there is something for all tastes. And overall, this remains an investment field with extremely high potential.
As countries' roads, bridges, power and water facilities depreciate, the need to repair and upgrade them emerges. A similar push for infrastructure occurs in developing countries as they build the roads and facilities they need for increased industrialization. Because this work is important for maintaining economic momentum in any country, infrastructure provides a solid area for investment, whether through individual stocks or with mutual or exchange-traded funds.