As the global economy enters a period of volatility with worries about inflation and interest rates, infrastructure as an investment has taken on a new appeal.
While not recession proof, these investments are recession resistant. In good times or bad, we use roads and need electricity and natural gas to heat our homes. Infrastructure is the economy’s version of plumbing, hidden from view but the underlying systems we depend on in all conditions.
The companies tend to be large and are often monopolies or near monopolies, given the size of their operations and the amount of money needed to invest in new facilities. But, they come with predictable cash flows and dividend streams.
“Infrastructure is an unsexy investment,” admits Chris McHaney, director and portfolio manager at BMO Global Asset Management in Toronto. “It is not going to blow the doors off with high growth. But it is a type of investment that is showing its benefits in a market like this.”
While the sector was once the domain of pension funds, the proliferation of exchange traded funds (ETFs) has made it more accessible to retail investors. Pipelines and power and water utilities are still its mainstays, but many include airports, toll roads and telecom companies.
Mr. McHaney oversees the BMO Global Infrastructure Index ETF (TSX: ZGI) which was among the first ETFs launched by the bank in 2009. It has $463 million in assets and 92 per cent of the holdings are in Canada and the U.S. About a third of the portfolio is in energy pipelines, another third in electric utilities and 20 per cent in Real Estate Investment Trusts (REITs) that own such things as cell towers.
Himanshu Sharma, managing director and head of fundamental research at TD Asset Management in Toronto, says in an inflationary environment these firms have the added benefits of being able to pass on increases to their customers. An added appeal in the current environment is a strong post-pandemic rebound after two weak years.
“If you think about toll roads or airports revenues, they are beneficiaries of reopening,” Mr. Sharma says.
Mr. Sharma is the portfolio manager for the TD Active Global Infrastructure Equity ETF (TSX: TINF) which was launched two years ago. It has $89 million in assets with holdings that are broader than the BMO ETF. It has a lower concentration of companies in Canada and the US and more in Europe and Asia.
Even so many of the holdings overlap. Both funds hold such Canadian names as Enbridge Inc., TC Energy Corp. and Pembina Pipeline Corp.
Mr. Sharma has recently added a financial services component to his fund, arguing that companies which offer payment networks are infrastructure at a time when online transactions are growing globally.
“Payment networks are essential to any kind of economic activity,” Mr. Sharma says. “Its just like a toll. If you think about it, each time we use a Visa or MasterCard, the transaction flows through their network, just like a toll road.”
Both analysts see infrastructure as providing a good portfolio diversifier with a blend of conservative growth and steady income. Share prices are unlikely to rise quickly, but appreciate slowly over time. For investors nearing retirement the sector offers less volatility in share price and for those with a long term horizon a way to grow with the economy.
“It is a stable foundation for any portfolio,” Mr. Sharma says.
Infrastructure investments carry some risks. There is potential for government meddling since the services they provide are considered vital. Hydro One investors learned that lesson when Conservative leader Doug Ford took aim at pay raises for executives, during the 2018 Ontario election campaign, somehow equating executive pay with high electricity prices.
Once elected premier, Mr. Ford replaced the CEO and board of directors and forced Hydro One to abandon plans to buy a utility in Washington State. Those moves sent the share price tumbling. Mr. Sharma notes that during the pandemic, the Chinese government forced toll road operators to temporarily suspend tolls.
Another characteristic is high levels of borrowing needed to build new facilities which often take years to finance before they come on stream. In an inflationary environment building costs rise as do debt servicing costs as interest rates rise.
Both funds have gained this year as investors increasingly view them as a place of safety in a challenging environment. Year-to-date the BMO Global Infrastructure Index ETF is up 5 per cent, while the TD Active Global Infrastructure Equity ETF is up 1 per cent.
By comparison, the TSX Composite index is down 6 per cent year-to-date.
As Mr. McHaney notes: “Infrastructure is not recession proof, but it is something we need all the time whether the economy is growing rapidly or slowly.”