Fueled by a well-documented need for increased infrastructure spending worldwide and drawn to the asset class’ diversification, income, and competitive returns, institutional investors continue to increase their allocations to infrastructure assets. This rise in popularity among the world’s largest investors has evoked increasing interest in infrastructure investing from a broader universe of investors, including sophisticated financial advisors and individual investors.
A Unique Asset Class
Broadly defined, infrastructure assets are the physical structures and networks needed for the functioning of a society. These assets can be divided into five categories of essential services:
- Transportation—toll roads, bridges, tunnels, parking facilities, railroads, airports, refueling facilities and seaports;
- Utilities/Energy—electric transmission and distribution lines, power generation, gas and water distribution, and sewage treatment plants;
- Construction—contractors, maintenance, design and engineering;
- Telecommunications—broadcast and wireless towers, cable and satellite networks; and
- Social Assets—hospitals, schools, correctional facilities, stadiums and subsidized housing.
Throughout the world, the owners of infrastructure are primarily government entities. However, the rising costs of building and maintaining infrastructure projects coupled with the fiscal challenges facing governments across the globe have spurred an increase in privatization, as evidenced by the roads, airports, and correctional facilities that have been privatized throughout Europe, Asia, and North America.
This shift from government-funded projects to private sector funding is presenting some potentially compelling new opportunities for investors due in part to the inelastic demand created by many infrastructure assets (roads, bridges, airports, seaports, etc.) and the high costs required to complete most projects, which helps minimize competitive threats for many companies in the sector.
Key Market Drivers
Growth Of The Emerging Markets Consumer
The emerging market middle class is experiencing unprecedented growth due to rising household wealth, increased productivity, favorable demographics, and low cost production. According to Morningstar’s, “Investing in the Emerging Market Consumer”, the number of middle class consumers in emerging markets may be larger than the middle class populations in the U.S. and Europe combined by 2020.
We believe the emerging market middle class is an important group of consumers for infrastructure spending, as their demand for clean water, energy, transportation, and telecommunications serves as a stimulus for much needed new projects and upgrades across these regions.
By 2030, the UN Department of Economic and Social Affairs, “World Urbanization Prospects the 2011 Revision”, projects more than 60 percent of the world’s population is expected to be living in urban areas—up from 48 percent in 2003. To keep up with the growing transportation, water, communications, and power challenges this migration into the world’s cities will create, local governments are expected to work closely with corporations in public-private partnerships to help close an infrastructure spending gap created by soaring urban populations and shrinking city budgets.
Increasing U.S. opportunity like most developed countries, the U.S. has substantial infrastructure in place; however, the condition of these assets is deteriorating rapidly. According to the American Society of Civil Engineers, “A Failure to Act”, the cumulative infrastructure investment needs in the U.S. will be approximately $2.7 trillion by 2020 and $10 trillion by 2040.
With tightened budgets and a polarized political system, many question the possibility of a sustainable framework to pay for these necessary infrastructure improvements. While there is no magic wand, successful examples in the U.S. include Jupiter Island, Florida, which used a system of utility company tax credits and user fees to bury all their power lines and The Ohio River Bridges Project, shared by three states, is a good example of the effectiveness of federal, state and private funding.
Advantages Of Investing In Infrastructure
The unique market dynamics of the infrastructure sector translate into several potential benefits for investors:
- Steady Income—a significant portion of the return on infrastructure investments is generated as income due in part to the nature of the asset class, which protects revenues from competitors.
- Diversification—international infrastructure securities, as measured by the S&P Global Infrastructure TR Index, are not closely correlated to the broader US and international equity markets or other asset classes including commodities and real estate.
- Competitive Returns—a portfolio of actively managed global infrastructure securities may have the potential to deliver competitive total returns relative to other asset classes. Over the past three years, the Alpine Global Infrastructure Fund has provided a 12.05 percent average annual return, outpacing the returns of the broader global equity markets at 4.30 percent (MSCI ACWI Index) and its benchmark, the S&P Global Infrastructure TR Index, at 5.64 percent as of 12/31/12.
Risks Of Investing In Infrastructure
Similar to any asset class, infrastructure-related assets are subject to a variety of factors that may adversely affect their business or operations, including:
- Regulatory and Political Risk—regulatory decisions can have a negative impact on infrastructure assets, particularly as these rulings relate to the regulation of rates charged to users, the imposition of special tariffs, and changes in government contracts and accounting standards. These risks are greater for investments in emerging markets.
- Interest Rate Risk—high interest costs in connection with capital construction programs can adversely impact infrastructure spending, as debt financing costs escalate with rising rates.
- Market Risk—infrastructure securities are subject to the risk inherent in any stock or security and may decrease in value because of factors related to the company or the broader industry.
Josh Duitz, Portfolio Manager of the Alpine Global Infrastructure Fund. Alpine Funds is an independent, research-driven asset manager based in Purchase, NY.