Infrastructure ETFs – An Ideal Way to Play the Mega Investment Theme of Global Economic Development

ETF Research written by the Barchart.com ETF Research Team

Last Updated: August 24, 2010

Table of Contents

Infrastructure has become a very attractive investment theme in the past decade.  Although the U.S. and Europe built their infrastructure assets long ago, much of that infrastructure is aging and needs to be replaced.  More importantly, the developing nations are in dire need of building their utility and transportation infrastructure systems to allow rapid and efficient economic development and to allow literally billions of people to rise from poverty.

Infrastructure refers to the common physical assets that a country needs to function.  Infrastructure assets include energy facilities (power, natural gas, pipelines), water facilities, waste facilities, telecom facilities, and transportation facilities (roads, bridges, airports).  The companies included in this sector are companies that build these infrastructure assets in the first place, or that own or manage infrastructure assets after they are built.

The main drivers for the infrastructure sector are population growth and economic development, as well as the replacement cycle for existing infrastructure assets.  Developing-country growth is also a key driver for the infrastructure investment theme.  There will be 2.2 billion people more on earth by 2050 than there are now.  According to the United Nations, the world’s population will rise to 9 billion in 2050 from the current level near 6.8 billion (see World Population Prospects: The 2008 Revision ).  This dramatic population growth will require more energy, roads, bridges, water and waste facilities.  The UN notes that most of this population growth will occur in developing countries, whose population is projected to rise by 2.3 billion people, from 5.6 billion in 2009 to 7.9 billion in 2050

Moreover, many developing countries are in the midst of a massive migration from rural areas to urban areas.  This migration presents business opportunities for companies that provide infrastructure because urban areas require a great deal more infrastructure than rural areas.  The UN projects that 60% of the world’s population will live in cities by 2030, up from 49% in 2005.  In terms of numbers, the UN projects that this urbanization trend will result in 1.7 billion more people living in cities by 2030, rising to 4.9 billion people from 3.2 billion people in 2005 (see World Population Prospects ).  Those 1.7 billion new urban dwellers will create the demand for a great deal more infrastructure to support their urban habitation.

In terms of dollars flowing into the sector, global spending on infrastructure will be $25-30 trillion over the next 20 years, according to a report by CIBC World Markets (see Capitalizing on the Upcoming Infrastructure Stimulus, CIBC World Markets, January 2009 ).  CIBC forecasts that roughly 40% of this money will be spent on transportation and almost one-third on power facilities.  Although fiscal stimulus during the recent recession played a part in generating excitement about infrastructure spending, governments and the private sector will be forced into spending money on infrastructure, stimulus or not, over the next several decades simply to meet the demands of modern economic development.

Sector Performance

The infrastructure sector, as represented by the iShares S&P Global Infrastructure Index Fund (IGF), has slightly underperformed the S&P 500 since December 2007, as seen in Figure 1 (click here for an updated version of this chart).  This is not surprising given the fact that the infrastructure industry is closely tied to the global business cycle, which has only recently improved after the worst global recession since the Great Depression.   Returns in the infrastructure sector should pick up once the global recovery gets fully into gear in the next 1-2 years.

Figure 1:  iShares S&P Global Infrastructure Index Fund (IGF) versus S&P 500 Index

Broad Infrastructure ETFs

There are currently two ETFs that cover the broad infrastructure space:

• iShares S&P Global Infrastructure Index Fund (IGF ) – This is the largest infrastructure ETF with over $400 million in assets under management.  The ETF has a rather long history dating from its launch in December 2007.  The ETF is heavily weighted in the Electric sector with a 39% weight.  The next largest sector weights are Commercial Services (19%), Pipelines (18%), and Engineering and Construction (10%).  Geographically, the ETF is heavily weighted in the U.S. and Canada (33%) and Europe (34%).  The largest holdings include TransCanada, Enbridge, E.ON, Atlantia, Abertis Infrastructure, and Spectra Energy.  The ETF’s dividend yield is high at 3.62% indicating strong dividend returns.

As the chart in Figure 2 shows, the performance of these two ETFs is fairly similar.  IGF was hit harder than the GII during the financial crisis in late-2008 and early-2009, but IGF has since caught up and the returns have been fairly similar (click here for the latest version of this chart).

Figure 2:  iShares S&P Global Infrastructure Index Fund (IGF) versus SPDR FTSE/Macquarie Global Infrastructure 100 ETF (HII)

Emerging Market Infrastructure ETFs

• PowerShares Emerging Markets Infrastructure Portfolio (PXR ) – This ETF has about $130 million in assets and has a fairly long history back to October 2008.  The ETF has a heavy 32% investment in the Engineering and Construction sector with Mining (16%) and Iron/Steel (13%) not far behind.  The ETF has a geographical allocation of 18% in China, 11% in Brazil, 10% in South Africa, and only 8% in the U.S.  The top holdings include Caterpillar, ABB, Shanghai Electric, Vale, Vinci SA, and Larsen & Toubro.

Industry-Specific Infrastructure ETFs

The term infrastructure has clearly become an investment buzzword and some ETF companies seem to be using the term to create some extra buzz for their ETFs.  However, these ETFs are only loosely connected to the broad theme of global infrastructure and are better analyzed with respect to their specific industry sectors.  ETFs in this category include the following:

• First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund (GRID ) – This ETF has about $30 million in assets under management  and was launched in November 2009.  The ETF is heavily weighted towards the U.S. with a weight of 58%.  Europe has a weight of 27% and Japan has a weight of 7%.  The largest holdings include SMA Solar Technology, Prysmian SpA, Quanta Services, Schneider Electric SA, NGK Insulators, and EnerNoc.  This ETF is essentially an electrical equipment sector ETF with a heavier weight on some of the newer-age electrical technologies such as solar inverters (SMA Solar Technology), demand response (EnerNoc), wind power electrical equipment (American Superconductor), and smart meters (Itron).

Our Investment Take

From an investment standpoint, the largest returns from the infrastructure sector are likely to come from those companies that are involved in building infrastructure assets in developing countries.  These companies are typically engineering and construction companies that have shovels in the ground.  They also include companies that provide the equipment to the infrastructure industry such as Caterpillar and others.  We are much less impressed with ETFs that simply invest in U.S. and European utilities and energy transportation assets that typically offer low volatility and nice dividends, but have less potential for capital gains and little or no exposure to the infrastructure needs of the developing world.

For investors who are looking for a broader and lower-risk ETF infrastructure ETF, we like the iShares S&P Global Infrastructure Index Fund (IGF).  However, its returns may be less than exciting due to its heavy North American and European focus and its low 10% weight on Engineering & Construction companies.  We would avoid the SPDR FTSE/Macquarie Global Infrastructure 100 ETF because of its smaller size and because of its relatively heavy focus on utilities.

For more aggressive investors, we like the PowerShares Emerging Markets Infrastructure (PXR ).  PXR has a heavy 32% focus on the Engineering & Construction sector and has a significant investment focus in China (18%) and Brazil (11%).  PXR has also reached critical mass with more than $100 million in assets under management.  Figure 3 illustrates how PXR since November 2008 has performed much better than IGF.  (click here for the latest version of this chart).  There is of course no guarantee this outperformance will continue, but we like the investment concept behind PXR much more than for IGF.

Figure 3:  PowerShares Emerging Markets Infrastructure ETF (PXR) versus iShares S&P Global Infrastructure ETF (IGF)

We like the concept behind investing directly in infrastructure companies in China and Brazil used by the Emerging Global Shares products, i.e. the INDXX Brazil Infrastructure Index Fund (BRXX ) and the INDXX China Infrastructure Index Fund (CHXX ).  However, the assets under management in these funds were very low as of July 2010 at under $50 million and that raises uncertainty about whether the ETF issuer is even breaking even on the products and whether the products will survive over the long haul.  Investors may want to just dip a toe in those ETFs, or alternatively invest directly in some of the constituent companies in the index.

List of Infrastructure ETFs from Barchart.com/ETF