Investors in infrastructure are taking a broader view of the kinds of stocks they want to own these days. That's partly in response to the slow pace at which U.S. government stimulus money is being funneled into public projects. It's also attributable to fund managers' hunger for stocks with more predictable cash flow and earnings prospects that are less tied to the strength of the economy overall—in other words, companies that enjoy a monopoly on facilities and services that get paid no matter how poorly the economy is doing.
Rapid economic growth and rising standards of living in developing countries such as China, India, and Brazil, and the accelerating trend toward urban living are driving the need to invest in core infrastructure systems such as water, electric power, and telecommunications.
There would seem to be more than enough money that needs to be spent on fortifying, if not rebuilding, America's bridges, highways, and water treatment systems—$2.2 trillion in investment over the next five years, by the American Society of Civil Engineers' calculations. The general condition of these essential assets is horrifying: The highest grade earned on the ASCE's 2009 infrastructure report card was a C+ for solid waste treatment, while nearly three-quarters of the categories rated a D, including roads, dams, and levees.
U.S. Global Diversifies The $787 billion stimulus package that U.S. lawmakers passed in February includes roughly $81 billion earmarked for public infrastructure. Of the $27.5 billion allocated for highway and bridge construction, only $2.8 billion in reimbursements has been applied so far by recipients, which suggests that just a little more than that has been spent in total, says Josh Duitz, who co-manages the Alpine Global Infrastructure Fund (AIFRX). He expects an additional $15 billion of the $27.5 billion to be spent in 2010.
In January 2008, sensing the economy was about to or had already entered a downturn, Jacek Dzierwa, an investment strategist who helps manage the U.S. Global Investors Global MegaTrends Fund (MEGAX), began to diversify away from construction and engineering (C&E) stocks into a broader range of companies, focused on alternative energy, water treatment, wireless communications towers, and steel production. He has also embraced companies in emerging markets such as Brazil and China, which he says have boosted the fund's performance this year. Year-to-date as of Oct. 15, the fund was up 27.5%.
One reason that he favors Canadian C&E stocks such as SNC Lavalin Group (SNC.TO) is that there are comparatively few large global companies in smaller markets to satisfy investor demand. Also, in Canada, provincial and federal money is flowing to projects faster than anticipated, especially in the second half of this year. The fact that SNC Lavalin employs French-speaking managers has helped it win contracts in French-speaking North Africa. Algeria is especially busy building desalination plants, liquefied natural gas plants, and roads, says Dzierwa.
Cohen & Steers Bets on Monopolies Robert Becker, director of infrastructure investment and research at Cohen & Steers Capital Management (CNS) and co-manager of the Global Infrastructure Fund (CSUAX), tries to keep his exposure to such cyclical plays to a minimum. Instead, he concentrates on companies that own and operate assets with monopoly-like characteristics that make it hard for would-be competitors to take away market share. Roughly one-third of the Cohen & Steers fund's portfolio was in utilities as of Sept. 30, and the regulatory climate is generally supportive of attractive returns on investment because policymakers understand how important these facilities are in aiding economic stability and growth. In the near term, however, the weak economy will make it more challenging for utilities to get approval to raise rates, despite the money some are spending on smart-metering and other energy-saving features. That's prompting Becker to be more careful in choosing utilities to buy. He prefers pipelines and electric transmission systems, which are regulated on the federal, not the state, level, and tend to be less restrictive on the rates. His fund is up 16.6% year-to-date as of Oct. 15.
Alpine Woods Capital Management likes to limit the Alpine Global Infrastructure Fund's position in companies whose revenues fluctuate with the economy to between 10% and 20% of the portfolio. "I'll own construction companies that own concessions," says Duitz, referring to those that not only build but own, operate, and collect fees on facilities such as toll roads. One name that fits the bill is Empresas ICA (ICA), which builds roads, dams, bridges and canals in Mexico. The Alpine fund was up 33.4% year-to-date as of Oct. 14.
Alpine Woods Diversifies with Stocks Historically, there has been less correlation between the performance of companies that own and operate physical assets and those of stock and bond markets, which makes them a good way to diversify an investment portfolio, says Becker at Cohen & Steers. The best-performing stocks over time are those with attractive dividend growth, which the large amounts of capital these companies tend to invest makes possible, he adds.
That's one reason that institutional investors such as pension funds and endowments, which have long invested directly in infrastructure assets, are more keen on investing in publicly listed infrastructure through buying stocks, says Becker. The advantages of these stocks include more liquidity than direct ownership allows, daily market pricing, and diversification, since institutional investors can now own a stake in a larger number of companies that in turn each own multiple assets.
Duitz at Alpine looks for specific themes to guide his stock picks in different countries. For example, only 10% of Brazil's roads are currently paved and that percentage is likely to increase as the economy further develops. One way to play that is by owning CCR, the largest owner of toll roads in the country, which can buy both paved and unpaved roads.
Another theme he likes is the rising demand worldwide for clean water. He owns shares of Cascal (HOO), an Anglo-Dutch company that provides water and wastewater services to homes and businesses in Britain, China, South Africa, and Chile, among others. More than half its revenues currently come from emerging markets.
Broadband Infrastructure One solid bet in the telecom industry, fund managers believe, is mobile-phone towers because of how much more broadband infrastructure is needed to accommodate increasingly data-intensive phone applications such as Internet service and music.
While Becker owns shares of two European satellite companies, Eutelsat Communications and SES, his preference in telecom is to own companies that own transmission towers. Despite the fact that iPhones and similar enhanced wireless devices seem ubiquitous these days, market penetration remains rather low. The more data-intensive the devices, the more bandwidth through wireless infrastructure needs to be built out to handle it. One advantage for tower owners such as American Tower (AMT) is that they have room to increase capacity utilization without any extra costs. "They've already made the sunk costs, so a lot of those [additional] revenues are falling right to the bottom line," says Becker.
Dzierwa plays the telecom theme by owning Vivo Participacoes (VIV), a Brazilian cellular telecommunications provider that offers a variety of services, including direct access to the Internet through data cards, multimedia message service, and an environment through which users can download applications on their wireless devices.
Dzierwa also likes Mexico-based Grupo Aeroportuario Del Sureste (ASR), which owns and operates nine airports near Cancun. Hotel occupancy rates in the larger Riviera Maya, which includes Cancun, dropped to 20% during the swine flu scare earlier this year but had rebounded by the summer to over 70% in some hotels that slashed their prices, he says. The fewer tourists, the less money airports earn in their duty-free shops, and the greater the potential for airlines to consider cutting flights to the area over the longer term.
Emerging Markets After the global economy returns to a more normal growth pattern, "we'll go where we believe the money will be spent," deciding on holdings on a company-specific basis, says Dzierwa.
By that accounting, investors probably should be ready to beef up their exposure to regions outside North America. Becker expects about $40 trillion to be spent worldwide on infrastructure projects over the next 20 years, of which the U.S. should account for roughly $7 trillion. U.S. stocks account for 26% of Cohen & Steers' fund, with 2% in Canada and the rest outside North America.
Owning stocks in emerging markets is less worrisome than a few years ago given how much more stable the governments in these countries appear to be, says Duitz. He steers clear of Russia, but feels comfortable with the lower level of political risk he sees in China and Brazil. The key to limiting risk when investing in emerging markets is to have a diversified position, so your risk is spread out, he says.