A few years ago, mutual funds and exchange-traded funds with the word “infrastructure” in their names began popping up. Fund sponsors latched on to companies poised to profit from the anticipated building boom in emerging markets and the upgrade of aging roads, schools and other public facilities in the U.S.

Individual sectors under the infrastructure banner, however, would seem to have little in common (they include utilities, railroads, transportation and telecommunications). Yet a growing number of investors, including pensions and other institutions, say infrastructure has emerged as a distinct asset class with its own unique flavor.

Among those investors is Joshua Duitz, the manager of the Alpine Global Infrastructure Fund. “Infrastructure companies have a number of common characteristics, including steady and predictable cash flow and inelastic demand for their services,” says the 42-year-old manager. “They also tend to be quasi monopolies or monopolies with high barriers to entry that are less sensitive to changes in technology than most companies.”

Such stocks can act as a hedge against inflation because the cost of replacing physical assets appreciates over time, and in many countries changes to the consumer price index dictates hikes in tolls and other fees. Investors facing a world of low interest rates also appreciate infrastructure companies’ generous dividend yields in the 4% to 6% range. (The Alpine Global Infrastructure Fund’s institutional shares recently posted a distribution yield of 3.9% after expenses.)

Yet even with their growing popularity among investors, many infrastructure companies have been forced to tread water as political bickering and scantily stocked government coffers push public projects to the back burner. A report released in February 2013 by consulting firm KPMG said 2012 was a challenging year for infrastructure companies. “Many governments around the world struggled to bring projects to market, and as a result, pipelines were thin. Financing markets continued to be tight, economic stability remained [elusive] and activity subdued.” With the economic slowdown, electric utilities in particular saw a decline in demand, and these are a major component of many infrastructure funds and indexes.

Selling the concept of infrastructure investing to the public has also been a slow build. Today, about a dozen mutual funds and eight exchange-traded funds focus on the group. Most of them still hold less than $100 million.

The performance has varied in these funds because of their different investment strategies and indexing methodologies. But the Alpine Global Infrastructure Fund has proved to be one of the more profitable entrants. Over the three years ended February 28, it had an annualized total return of 15.9%, while the MSCI EAFE Index returned 6.85% and the iShares S&P Global Infrastructure Index Fund (IGF) returned 7.63%.

Duitz attributes the outperformance thus far to his exposure to utilities, which is lower than that of his competitors, and his exposure to emerging markets, which is higher. “A lot of infrastructure funds began life as utility funds and morphed into something else,” he says. “Others follow indexes that have heavy exposure to utilities. Neither is the case with this fund.”

Going forward, he has more modest performance expectations for the fund. “I think over the longer term, an annualized return of 8% to 12% would be a realistic expectation,” he says. “That’s still better than what we expect from the broader markets.”

Launched in late 2008, the Alpine Global Infrastructure Fund has managed to outshine its rivals by deviating from the typical infrastructure script. Again, it has much less utilities exposure—only 23% of assets, much less than the S&P Global Infrastructure Index’s 37% (and other mutual funds’ stakes, which can be as high as 50%). The fund instead has more presence in transportation construction and operations (railroads, airports and toll roads). These plays represent 32% of the fund’s assets, which is much more prominent than they would be in other infrastructure portfolios.

The same holds true of emerging markets, where the fund has about one-third of its money. Brazil, which accounts for 11% of assets, tops Duitz’s list of favored foreign countries. With the World Cup slated to take place there in 2014, and the Olympics on the horizon in 2016, the country has ample motivation to shore up its infrastructure and meet construction deadlines.
 

By contrast, India accounts for less than 1% of the fund. “It’s difficult to find infrastructure investments there that we like,” Duitz says. “The company managers we’ve met with there do not give us confidence that they’ll be able to execute their plans. The same holds true on the government side. If they say they are going to build X, it often turns out that they build just half of X.”

Improving Outlook
Duitz believes that even in the face of slow economic growth both here and abroad, many infrastructure companies in the fund will deliver solid earnings growth in the years to come. Emerging market governments will need to build more roads, bridges, railroads and other facilities as those countries continue to urbanize. Since September of last year, China and Brazil have announced major projects to stimulate the economy and shore up facilities in major cities and the surrounding areas.

For that reason, the KPMG report sees better times this year as the backlog of new projects hit the market and economic conditions improve. Governments have also shown an increased willingness to support infrastructure with regulation and financial backing, the report adds, and that should also help move these projects forward.

In another favorable trend, cash-poor but asset-rich states and municipalities in the U.S. are relying more on the private sector to undertake major projects.

Beyond the macroeconomic picture is the issue of stock prices, which have become more expensive as investors chase infrastructure companies. Duitz views the current prices as reasonable given the stocks’ earnings growth prospects, and believes that with more infrastructure mutual funds and ETFs coming to market, this corner of the investment world “is really just starting to get off the ground.” He says the financial advisors he has spoken with often use the fund as part of their global allocation strategies, or as a high-dividend play in place of utility stocks.

To find names with the best chances for long-term appreciation, Duitz first tries to determine which countries offer the most hospitable environment for infrastructure build-out, and which countries could see their projects stall because of political or economic roadblocks. Price is also an important factor; as a value investor, he often seeks out stocks that investors are ignoring or punishing for what he thinks are temporary setbacks.

At 33% of assets, U.S. companies claim the most dominant geographic stake. One of the trends in the U.S. is to have private companies complete public projects in exchange for accelerated revenue. Duitz believes that this trend offers opportunities for expansion, even in a slow-growth environment. In Texas, for example, the Spanish construction company Ferrovial SA (one of Alpine’s holdings) is spearheading a major highway building project. Eventually, Ferrovial will be rewarded with a share of the toll revenue the highway generates.

The nation’s prison system has also become an increasingly fertile area for these so-called public-private partnerships as more governments decide to hand facilities management over to outside companies. One of Duitz’s holdings is the GEO Group, the largest provider of correctional and detention facility services in the world, which operates 101 such facilities in the U.S., Australia, the U.K. and South Africa. The first real estate investment trust specializing in the corrections facility industry, it trades at a discount to other REITs.

Another U.S. holding is the Williams Companies, which owns 15,000 miles of natural gas pipelines and delivers 14% of the natural gas consumed in this country. Duitz likes the company’s “take or pay” contracts, which obligate gas producers to pay Williams regardless of the amount of gas that moves through the pipelines.

The fund also owns a number of railroad companies, including Brazil’s All America Latina Logistica SA. The largest railroad operator in the country, it transports mainly agricultural products. Given the company’s expected 30% earnings growth next year, it is trading at a discount to U.S. railroads. The stock has become that kind of bargain because investors are worried about the impact of possible government-imposed price caps on transport services. But Duitz believes such concerns are overblown.

Another Alpine holding, China Railway Construction Corporation, trades at a modest 7.5 times 2014 projected earnings. The company’s earnings growth should clock in at about 10% over the next couple of years as Chinese government reforms pave the way for increased project spending.

Turkey’s Tav Havalimanlari, one of the fund’s less-well-known holdings, constructs airport terminal buildings and operates airports in several locations, including Istanbul. The stock is currently trading at a significant discount to similar European companies because it could lose the concession for Istanbul’s airport after the government completes the construction of a new facility. “There is upside if Tav wins the new contract,” says Duitz. “And if it doesn’t, it will still be compensated when the old facility shuts down.”