Infrastructure investing builds on a solid foundation

Core infrastructure businesses consist of installations such as maritime ports, water-distribution systems, airports, power-generation facilities, telecommunications networks and hospitals. Increasingly, these types of infrastructure are managed as public-private partnership agreements. At the periphery of the infrastructure segment are suppliers such as manufacturers of aircraft, trains and construction materials and equipment.

Pension funds and other institutional funds are major direct investors in infrastructure projects, but this avenue is out of bounds for retail investors. "Projects don't offer ready liquidity," explains Alfred Lee, vice-president, portfolio manager and investment strategist at BMO Global Asset Management Inc., in Toronto. "For an ETF, the underlying assets -- stocks -- must offer daily liquidity, which is not the case with the underlying projects." This is also true of mutual funds that specialize in infrastructure stocks.

The concept of infrastructure equities as a distinct fund category is fairly recent. "It's only around 2005 that Australian managers developed an interest in infrastructure and identified it as an investment sector," recalls Alain Latreille, product director of fixed-income funds at Desjardins Wealth Management, in Montreal. In Canada, Latreille notes, we had to wait until 2015, when the Canadian Investment Funds Standards Committee (CIFSC) created the category.

In 2005, the capitalization of infrastructure equities totalled US$400 billion worldwide, adds Latreille. Today, that has soared to between US$2 trillion and US$3 trillion. If projections by the McKinsey Global Institute hold, the sector should grow to US$49 trillion by 2030.

The Canada retail market's place in infrastructure investing is still modest. Total capitalization amounts to $5.7 billion, spread across 31 mutual funds and ETFs offered by nine providers.

Some Canadian funds have fared very well. For example, Desjardins Global Infrastructure Class F, which has a 5-star Morningstar Rating, has a compound annual return of 10.5% over the last three years, outperforming the 6.4% average return for the category as a whole in Canada. The Desjardins fund is sub-advised by Colonial First State Asset Management (Australia) Ltd., which manages a fund with a similar mandate for Australian investors. That fund has returned an annualized 13% over its 15 years of existence, Latreille says.

Another notable Canadian-domiciled fund is the Morningstar 4-star rated Russell Investments Global Infrastructure Pool Series F. It has returned 13.6% since its inception in January 2013. Only five funds in Canada in this category have a 10-year track record. Among them is Dynamic Global Infrastructure Series F, which has a 4-star Morningstar Rating and a compound annual 8.7% return since its inception in July 2007.

The rapid growth of infrastructure industries, and their robust stock returns, have several main drivers. An early impetus came from the Chinese economic boom and the massive infrastructure investments needed in that country.

Secondly, developed countries have a lot of catching up to do. "Since the financial crisis, iinvestment in infrastructure has actually declined as a share of GDP in 11 of the G20 economies, despite glaring gaps and years of debate about the importance of shoring up foundational systems," according to Brad Fishberg, lead manager of BMO Global Infrastructure at Macquarie Investment Management in Philadelphia.

Finally, corporate and government restructurings have exposed huge chunks of infrastructure assets that were previously hidden in company portfolios. In Canada, we've seen the spinoff of autonomous companies like  Enbridge Inc. (ENB) and  Pembina Pipeline Corp. (PPL), and in the U.S. of  American Tower Corp. (AMT) and  Crown Castle International Corp. (CCI). The creation in 2015 of Hydro One Ltd. (H), previously owned by the Ontario government, is a prominent example of infrastructure privatization.

Macquarie's Fishberg cites multiple macroeconomic trends contributing to the growth of infrastructure. The first is the accelerated urbanization in many countries. The second is population growth in many developing economies, accompanied by increased industrialization and consumption. Thirdly, there's the need to upgrade outdated installations and the priority given to sustainable development and eco-friendly solutions. Finally, emerging technologies, especially in artificial intelligence, will increase the efficiency and productivity of infrastructures.

As Fishberg points out, infrastructure equities face a few headwinds. Regulatory constraints on banks make financing more difficult to obtain, and government debt constraints make new projects less likely to receive public-sector support.

"The market is still growing and will continue to do so, but growth will now be more measured and balanced," predicts the Investors fund's manager Hazboun. For his part, Desjardins' Lessard forecasts annual dividend yields of 3% to 4% for the foreseeable future, and that companies will be able to increase spending thanks to growing profits. But the sector's annual growth will settle more in the 6% to 8% range, he adds.

Apart from healthy growth prospects, the other attraction of infrastructure for investors is the sector's relatively weak correlation to broad market indexes, which Latreille estimates is between 0.6 and 0.7. "In a bull market, he says, our participation rate is about 80%, and in a bear market, about 40%. Therefore, it's a defensive sector that still grabs its fair share of growth."

Dividend stability and growth predictability of the infrastructure sector have led financial advisor Robert Denis, founder of Gestion C.R.D., in Montreal, to favour infrastructure funds over bond funds. "For three years now, I've emptied my portfolios of almost all bond holdings, and replaced them with dividend-yielding assets (such as infrastructure funds)," he says.

At that time, Denis recalls, he listened to people from PIMCO, one of the world's largest bond managers, explain that, to obtain more yield, they had to move from AAA bonds to higher-yielding and more risky assets. "I find that dividend-yielding assets, like infrastructure, are not riskier and perform just as well, if not better."