If you live in the United States and listen to the news, you have probably noticed that hardly a week will pass without hearing about our "nation's crumbling infrastructure." It is well known that our bridges and highways need repair -- along with numerous other public works projects that require attention.
As a result, global infrastructure spending has the potential to grow significantly. The demand is not only growing from developed economies that need to repair or replace aging infrastructure assets but also from emerging countries like China and India, which are building out their infrastructure as they grow. This leads to a huge funding gap between infrastructure needs and available public funding that will have to be covered by private investments. Long-term assets, such as infrastructure investments, have been shown to be valuable assets for both institutional and retail investors.
Here are three reasons to consider these kinds of investments:
1. Below-Average Business Risk
Listed infrastructure companies have below-average business risk because, in many cases, they are providing something critical for a country, such as railroads, highways and sewage systems. Also, they operate in non-competitive business environments due to, in many cases, exclusive long-term contracts with local governments. The Manila Water Company in the Philippines, for example, holds a 25-year concession agreement granting it exclusive rights to the use of land and facilities for the production, treatment and distribution of water, as well as the right to operate the sewer system. These long-term deals provide revenue protection and often lock in price increases that are marked to inflation.
2. Higher Operating Leverage
Infrastructure companies have higher operating leverage (a company's level of fixed costs relative to variable costs), which can lead to significant free cash flow increases when unit volume rise. Combined with low business risk, this high operating leverage allows infrastructure companies to support comparatively high dividend payout ratios. Between 2007 and 2013, for example, the average dividend payout for infrastructure companies was about 19 points higher than that of non-infrastructure companies. The dividend itself averaged almost 4% over that timeframe, making public infrastructure even more attractive as an investment.
3. Strong defensive investment characteristics
Critically, infrastructure companies have strong defensive investment characteristics. In addition to low business risk and high dividend payments, the average beta for infrastructure companies is low. Infrastructure companies have less exaggerated price movements than the market while maintaining equivalent or better performance. Listed infrastructure assets provide lower total risk compared to the global equity market.
How to Invest in Infrastructure
A diversified infrastructure portfolio provides stable cash flow driven by strong commercial models that are protected by barriers to entry and inelastic consumer demand. But there's a problem for the typical investor. Infrastructure investments have only been available to institutional investors via private investments, that is, unlisted investments. The challenge for the typical investor is to find public companies that capture the beneficial characteristics of unlisted infrastructure in a diversified portfolio of listed equities.
A suitable solution is to gain exposure to infrastructure through indices such as the STOXX Global Broad Infrastructure Index (disclosure: I am a senior executive at STOXX).
Currently, about 40% of the components are U.S. companies and 60% are global companies. The index provides an appropriate benchmark for equity investors who have long-term saving needs and require strong stable income and the potential for capital appreciation over time. The index's low market exposure is beneficial for investors who want to increase diversification in their overall portfolios. In fact, in the first four months of 2016, the STOXX Global Broad Infrastructure Index outperformed the STOXX Global 3000, which is a broad yet liquid representation of the world's equities markets with a fixed number of 3,000 components, by more than 6.5%, and it has an above-average 12-month trailing dividend yield of 3.11% as of the end of April.
The index, investable through the FlexShares STOXX Global Broad Infrastructure Index Fund (NFRA) - Get Report , can provide investors with diversified exposure to a strong set of infrastructure companies.
<P><I>This article is commentary by an independent contributor. At the time of publication, the author held TK positions in the stocks mentioned.</I>