Here is a Q&A with Jaylene Howard, consulting director of the advisor-sold business at Russell Investments, looking at the case for, and drawbacks of, investing in infrastructure.

Here is a Q&A with Jaylene Howard, consulting director of the advisor-sold business at Russell Investments, looking at the case for, and drawbacks of, investing in infrastructure.

“Once investors understand that infrastructure assets are the very things that make up the backbone of our economy, they are usually keen to listen.”

Firstly, could you summarize, perhaps including a few bits of data as support, the case for investing in infrastructure? 

There is an enormous, global need for investment in infrastructure – think roads, power, water, telecoms; the services that are essential for a functioning economy – both in developed and developing economies.

A 2013 McKinsey Global Institute report (Infrastructure productivity: How to save $1 trillion a year) estimated $57 trillion will be required to modernize and expand infrastructure around the world by 2030. While the developed world is focused on updating their infrastructure, the emerging world is focused on building their infrastructure to meet the demands of rapid growth and urbanization.

What are the main advantages for high net worth individuals investing in infrastructure?

For many investors, diversification needs to go beyond traditional methods (i.e., just stocks and bonds). Incorporating exposure to asset classes like infrastructure can be beneficial from a diversification standpoint. For infrastructure specifically, it tends to offer access to growth opportunities (supported by long-term trends), income generation, and a potential offset to inflation. The two most important though, are diversification and defensiveness.

One segment of the infrastructure market we find compelling – “pure play” companies that own and operate infrastructure assets – tends to have stable and more predictable cash flows derived from long-lived assets with monopolistic-like pricing power. This can help investors looking for yield and a potential offset to inflation. Infrastructure assets tend to have a differentiated return pattern and lower volatility profile than global equities offering diversification benefits to investors, particularly those looking for a more defensive equity alternative.

What about downside protection?

Exposure to listed infrastructure has historically provided defensiveness in a portfolio in weaker markets. We looked at return data during periods of negative world equity market performance and found 15 such quarters since 2001. In 12 of those 15 quarters, global listed infrastructure (as measured by the S&P Global Infrastructure Index) outperformed world equities (as measured by the Russell Global Index), on average, delivering 3.5 per cent in excess of world equities.  

How do you recommend HNW individuals go about investing in infrastructure? Exactly what kind of opportunities does this asset class present (and how are firms accommodating clients in this way)? 

And

Would you say it has been challenging for investors to find the right investment vehicle that provides comprehensive access to this element of the “real assets” class?

And

What are your long-term views in terms of investor momentum in this space?

There are multiple ways to gain access to the infrastructure market – via listed infrastructure funds, private infrastructure funds, ETFs, and indirectly through infrastructure-related companies.

It’s likely many investors already have some indirect exposure to infrastructure via their equity investments, for example, in utility companies. More direct exposure via focused infrastructure funds is an investment area that has meaningfully expanded since 2000, giving investors an emerging opportunity to diversify their assets.

Listed infrastructure funds can offer low capital, transparent and liquid access to the market with the benefits of active management. We think that is important in this space as passive options tend to be skewed toward non-pure play companies that don’t that actually own and operate infrastructure assets (e.g. large-cap diversified utilities, high beta power companies, and diversified communications).

In this area, we find “pure-play” investments appealing, or those that tend to be monopolistic or highly regulated assets with steady cash flows (e.g. transportation, highly regulated utilities, pipelines). As well, actively-managed portfolios with exposure to infrastructure tend to have more balanced sector exposures which allows for a stronger diversification profile.

We have found that individuals can easily “connect” to the idea of investing in infrastructure as these are tangible assets that we need and use every day. We use airports and toll roads to travel; we need towers to use our cell phones. Once investors understand that infrastructure assets are the very things that make up the backbone of our economy, they are usually keen to listen.

As a result of this and the growing recognition of the role infrastructure can play in a diversified portfolio, you can see the growth of listed infrastructure assets over time by looking at funds in the Morningstar database. Of the 13 infrastructure funds, only 4 existed prior to 2008 and assets in these funds have grown from $771 million in June 2010 to $4.96 billion in May 2013. We think interest will continue to grow as investors learn more about the advantages of infrastructure investing.

What are the primary risks associated with this asset class?

Investments in infrastructure-related companies can have greater exposure to the potential adverse economic, regulatory, political and other changes affecting such companies. Since the universe of infrastructure assets is global, investment in non-US and emerging market securities can also be subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries.

What global forces might have the most impact on the performance of this asset class?

Political and regulatory action can impact infrastructure projects or companies. For example, governmental regulations (e.g. a change in taxes or tariffs), high interest costs associated with capital construction programs, costs associated with compliance and changes in environmental regulation, economic slowdown and surplus capacity, can all impact infrastructure assets.

Which economies would you say are the "ones to watch" for now?

Emerging markets continue to be a key area of growth in the global opportunity set. Currently, emerging markets make up about 9 per cent of the S&P Global Infrastructure Index (as of June 2013). The McKinsey Global Institute report quantified the opportunity in emerging markets this way: “Over the past 18 years, advanced economies have been responsible for more than 70 per cent of global infrastructure investment. Over the next 18 years, emerging economies are likely to account for 40 to 50 per cent of all infrastructure spending.” (Source: McKinsey, 2013).

What advice would you give to those investors who are considering an allocation to global listed infrastructure?

Given the essential role of infrastructure assets in serving as the backbone for economic growth, the sector is an emerging opportunity for investors. In a portfolio context, exposure to infrastructure can offer investors a strong source of diversification, a defensive role in the portfolio (low beta, low volatility, and downside protection vs. broader global equities), yield and attractive total returns.

Could you describe the kind of investor who would be particularly suitable for this type of investment?

We see interest in infrastructure from institutions to individuals and for different reasons. The most common reasons we see investors add a dedicated allocation to infrastructure are: they seek a strong source of diversification, a defensive role in the portfolio (low beta, low volatility, and downside protection vs. broader global equities), yield and attractive total returns.

Where does the US currently sit in the global infrastructure investing picture? Where does infrastructure currently sit in the investment picture more broadly?

Infrastructure investment opportunities span the globe, offering investors access to both developed and emerging markets.

To give some perspective on the US vs global infrastructure opportunity, it’s helpful to look at the regional breakdown of the S&P Global Infrastructure Index (as of June 2013):  42 per cent North America, 26 per cent EMEA ex-UK, 12 per cent Asia-Pacific ex-Japan, 9 per cent emerging markets, 8 per cent UK, and 3 per cent Japan.

As part of the larger investment opportunity set, infrastructure is a small but growing piece. Where the market capitalization of the Russell Global Index was $49.5 trillion (as at end-December 2012), the market capitalization of the S&P Global Infrastructure Index was $778.6 billion (as at end-December 2012).