Companies involved in industries such as construction, electric power, raw materials, transportation and energy are the drivers behind the coming build-out in both developed and emerging market countries, and infrastructure ETFs can help investors capitalize on the boom.
That's the message ETF sponsors have been sending out since infrastructure funds debuted in this space about three years ago.
Sponsors cite statistics to underscore the relevance of the theme. The Organization for Economic Cooperation and Development, for instance, says $71 trillion will be needed in infrastructure spending worldwide by 2030, while the American Society of Civil Engineers believes the U.S. will need to spend $2.2 trillion over the next five years to bring the country's critical systems up to snuff.
With a rapidly expanding middle class needing everything from highways to electricity, emerging markets are just beginning to address their growing infrastructure needs. Euromonitor International, a market research firm, predicts that consumer spending in China, Brazil and India will grow 8% annually over the next decade, and only 2% per year in the U.S.
Emerging market governments also appear ready to allocate money to projects. While the U.S. spends 2.4% of GDP on infrastructure investment and Europe 5%, China has devoted some 9% of its GDP to public building and improvement projects over the last few years.
But infrastructure ETFs also possess risks. Utilities, often a major component of the group, are highly regulated industries subject to stringent price controls and environmental regulation. While the stocks have defensive characteristics such as high yields, they tend to plod along in bull markets and can feel the brunt of rising interest rates.
Two other infrastructure sectors, construction and materials, are cyclical industries whose fortunes follow fluctuations in commodity prices and economic conditions. Public projects depend heavily on government financing, which hasn't been plentiful in some countries. Emerging markets also face political risks. Even if spending were to increase on infrastructure projects, unfavorable markets could hold back the stocks that should benefit.
Yet to some investors, infrastructure has classic appeal. A report from Brookfield Asset Management, a firm that specializes in infrastructure investments and has created two related Dow Jones indexes, cites a number of reasons to invest in these companies, and the firm even segregates them as a distinct asset class. Given the high barriers to entry into the market, infrastructure companies face little or no competition from small upstarts. Because they provide essential products and services, their revenues are insulated from big fluctuations in demand. They can also be good inflation hedges because their cash flows are often linked to measures of economic growth such as GDP, and they have a low correlation to other types of investments.
For those interested in the theme, though, it's important to check under the hood, since people define infrastructure in different ways. Some broad infrastructure indexes focus on industrial metals and materials companies or construction-related businesses, while utilities rule the roost elsewhere. The indexes follow different countries and have different risk and return profiles. Many ETFs, while they aren't specifically labeled as infrastructure funds, follow sectors that stand to benefit from a ramp-up in construction, transportation and building projects.
Tom Graves, an equity analyst with Standard & Poor's, identifies 32 infrastructure-related ETFs covering a broad range of sectors such as utilities, construction, transportation, alternative energy and materials. These funds have a market capitalization of $17.6 billion altogether. Only two of the funds, both in the alternative energy category, had negative returns for the year ended March 31. The others generally posted returns of 10% to 20%, winning favorable comparisons with the mid-teens return for the S&P Global 1200 Index.