Crumblin’ Down: The Advantages of Infrastructure Investing
When I took my father to see John Mellencamp at Toronto’s Massey Hall for his birthday last year, I likely shouldn’t have been drawing parallels between the Cougar’s lyrics and infrastructure investing. That said, after spending three hours driving through construction on the 401 coming in from Guelph (98.9 km away), when he started belting out the song Crumblin’ Down, I couldn’t help but think of the state of our Canadian infrastructure. If, for a moment, we do consider that theme and listen closely to his lyrics, he does question, “what to do when success eventually fades,” and although he doesn’t follow that line with, “when our infrastructure continues to age,” Mr. Mellencamp was completely accurate when it comes to infrastructure — “everybody's got their problems, ain't no new news here, it’s the same old trouble you've been havin' for years”.
We’ve known for years that aging infrastructure is a serious problem on a global scale, an issue that we realize needs to be addressed immediately. The World Economic Forum states “global spending on basic infrastructure; transport, power, water and communications currently amounts to $2.7 trillion a year”. That seems like a very large number, but the same report mentions that the spend should actually be $3.7 trillion. It shows that there is a real gap, and the spread seems to be growing exponentially[1].
After the end of World War II, Canada invested heavily in our public infrastructure. Everything from roads to rail, the 50s and 60s was a period of unprecedented infrastructure investment. Unfortunately, over the past 60 years, the level investment in infrastructure has not been sustained. In fact, from 1962 through 2003, we have witnessed a 50% decline in annual government per capita capital investment on infrastructure[8], which means that today we are facing a real challenge of having to fund our infrastructure rehabilitation quite rapidly, before it all comes “Crumblin’ Down”.
According to the highlights from Canadian Infrastructure Report Card, published by the Association of Consulting Engineering Companies of Canada, approximately 30% of municipal infrastructure ranked “fair” to “very poor” and replacement cost of these assets totals $905 billion nationally [4]. This underinvestment in infrastructure will have a negative impact on the domestic economy, suggesting that the long-term profitability of Canadian businesses will be impacted by an average of 20%[7].
There is a positive in this – as investors, we are always seeking trends and recognizing investment opportunities to “get a leg up” when it comes to constructing portfolios. The investor landscape is beginning to understand the significant opportunities of the infrastructure assets class and the benefits of including infrastructure investments in their portfolios. We strongly feel that including infrastructure allocation is not only prudent investing, but we also feel that we are at a significant point in history, a true opportunity to look to allocating capital to certain infrastructure investments to enjoy benefits that have historically only been realized by large institutional investors.
Understand Infrastructure
In Keynesian economics, the word infrastructure was exclusively used to describe public assets that facilitate production, but not private assets of the same purpose[2]. It actually wasn’t until the 1980s that the term “infrastructure” became a common term, after the publication of Pat Choate’s book America in Ruins: The Decaying Infrastructure.[5]. Today, the reference to infrastructure includes roads, tunnels, bridges, airports, rail links, and ports; regulated infrastructure such as electricity distribution/transmission, gas and water distribution. Infrastructure also includes social investments, such as hospitals, aged care, schools, courthouses, and prisons. Infrastructure provides countries and economies with the essential services they need to function, grow and prosper.
The inherent infrastructure catch-22 is as strong infrastructure and infrastructure-spending cities and countries continue to grow and prosper (which increases demand and usage) they in turn escalate the capital required to maintain the assets. Countries around the world therefore have underinvested in infrastructure for decades and are now faced with the task of building and renewing essential services. As capital required is significant, governments are turning to the private sector for funding, which has created a unique investment opportunity.
Understand The Benefits
Investing in infrastructure offers investors some very compelling benefits including strong stable growth, low volatility, enhanced diversification, steady yield and inflation protection.
Stable Growth & Low Volatility:
Since the demand for infrastructure and essential services remains constant, infrastructure consistently requires investment, regardless of how the economy is performing. This stability coupled with the long-term nature of infrastructure projects suggests that the asset class offers predictable, relatively stable long-term returns.
Solid Diversification:
The alternative, non-traditional nature of infrastructure investments provide a low correlation to traditional asset classes, enhancing the diversification of an equity/fixed income portfolio.
Steady Yield and Inflation Protection:
Given the significant capital requirements for infrastructure projects, companies managing projects tend to offer higher attractive yields as projects mature. As infrastructure earnings are predictable, dividends are usually sustainable over the long-term. This is also complemented by the fact that infrastructure revenue is often linked to inflation, it can act as a hedge against it—fantastic in today’s environment.
Investment in infrastructure has traditionally been the domain of large institutional investors given the sheer mass of capital required. In the May 2013 edition of Infrastructure Investor, a survey of 62 institutional investors (representing $1.9 trillion of capital) indicated that infrastructure is at the very top of their shopping lists. A recent example of strong demand was seen this year, on July 12, 2016, when Brookfield closed their $14 billion Global Infrastructure Fund, raising $27 billion in 18 months.
In the 2014 Global Alternatives Survey, sponsored by Towers Watson and the Financial Times, alternative assets managed by the top 100 asset managers total $3.3 trillion USD. Of this, $120.6 USD billion relates to infrastructure, 52% of which was invested in European infrastructure and 26% of which was invested in North American infrastructure, with the remainder split between Asia-Pacific and other regions.
Since the mid-1990s, we have seen a rapid increase in the options for retail investors to participate and infrastructure assets are becoming much more widely held by a larger audience who are attracted by the sector’s defensive characteristics [2].
Today, investment advisors and retail investors can access infrastructure investments through ETFs, open-ended mutual funds or closed-ended infrastructure funds; vehicles that provide us an opportunity to invest in both public and now private infrastructure investments. Investors today can find options to fit any investment strategy – equity or debt, country or geography, there are options to access specific asset types or certain yield objectives which are all worth exploring.
Understand The Risks
As we’ve said before, there’s always risk in investing and with all the options available to us, it’s even more important to ensure that we are evaluating the investment options and conducting thorough due diligence as we construct portfolios. In the infrastructure space, with the increasing interest in core, income-producing infrastructure, there is concern that there will be less pricing discipline by investors so it’s important to look under the hood and understand the drivers of return and the strategy behind each investment [2].
When evaluating infrastructure investment, some of the risk to consider include market and economic risk, regulatory and political risk and, perhaps the most relevant is interest rate risk and liquidity risk.
Understand The Opportunity
As we have highlighted in previous articles, we believe that alternative assets play an important role in any well-diversified portfolio, as long as the risks are completely understood. Alternatives can be used not merely to enhance growth but can serve to minimize risk, provide downside protection and enhance the income our clients generate.
We firmly believe that infrastructure, as an asset class, plays an important role in portfolio construction for all these reasons and understanding the global need for capital and investment into the infrastructure space now more than ever, we, as investors, can turn a real challenge into opportunity. The pain of our aging infrastructure could be turned into an opportunity which, if we stretch it a little, could give investment meaning to “Hurts So Good”.
G. Derek Henderson, Portfolio Manager, The Bush-Henderson Investment Team, CIBC Wood Gundy. Email: Derek.Henderson@CIBC.com www.Bush-Henderson.com
1- Investing in infrastructure, The trillion-dollar gap, How to get more of the world’s savings to pay for new roads, airports and electricity, Mar 22nd 2014 The Economist
2 - America in Ruins: The Decaying Infrastructure (Duke Press Policy Studies Paperbacks) Paperback – January, 1983 by Pat Choate
3- Investing in infrastructure, The trillion-dollar gap, How to get more of the world’s savings to pay for new roads, airports and electricity, Mar 22nd 2014 The Economist
4 - http://www.acec.ca/advocacy/voteinfrastructure/facts.html
5 - http://apworldromehistory.weebly.com/infrastructure.html
6 - Highlights from the Canadian Infrastructure Report Card
8 - Mind the Gap: Finding Money to Upgrade Canada’s Aging Infrastructure.
TD Bank Financial Group, 2004
7 - Public Infrastructure Underinvestment: The Risk to Canada’s Economic Growth [7]
Residential and Civil Construction Alliance of Ontario, 2010