Our daily usage of these services, regardless of the economic environment, creates a stable demand for them and represents generally increasing cash flows over time which makes these potential businesses interesting from an investment standpoint. We are all indirectly invested in the infrastructure sector because of our government-sponsored pension plans. They have invested between them (CPP & CDPQ) $45 billion in private assets in this sector across the globe. As a self-directed investor, there are also publicly listed infrastructure securities that you can purchase in your brokerage account, either as individual securities or via a mutual fund or ETF.
Starting in the 1990s, cash-strapped governments in the developed world, and later emerging economies requiring investment dollars, looked for ways to renew or grow their infrastructure and found institutional investors (sovereign funds, pension plans, private equity) who were willing to buy or build infrastructure projects and to manage them because of the attractive potential returns.
Different Types of Infrastructure Assets
Infrastructure assets can be private (accessible mostly to institutional investors) or publicly listed (accessible to retail investors) and are grouped into two general categories. The first is composed of regulated infrastructure assets, where the regulator, usually a government agency, determines the revenues that the operator can make (e.g. an electric utility). User pays assets comprise the second one, where revenues depend on how many people use the infrastructure, such as a toll road (number of cars) or an airport (number of passengers and planes). Both types of assets generally have a wide moat protecting them from direct competition either because of regulation and long-term contracts or by design (one cannot simply build a highway anywhere). The lack of competition and their long-term lifespan create ongoing advantages for these assets which I will explain below.
Advantages of Infrastructure Assets
- Stable cash flows: Derived from the wide moat, they provide good visibility for growing revenues and dividends over the long term.
- Inflation protection: Regardless of their type, most infrastructure assets feature an annual built in revenue increase to offset the effects of inflation.
- Lower volatility: Since these assets are used daily, there is a consistent demand for them regardless of the economic conditions. This predictability makes these securities less affected by big swings in the market in either direction. Lower business volatility generally will also mean lower volatility in the listed shares as well.
- Diversification: Infrastructure securities are part of the equity asset class, but they have a low correlation with other equity classes as well as a low BETA. For this reason, they are added to portfolios to help diversify the equity portion without necessarily taking away the return potential of that category. Infrastructure securities are almost a hybrid between stocks and bonds.
One disadvantage of this asset class for retail investors is that the publicly listed securities behave just like other equity securities over the short term or during sharp market corrections, but, over the longer term, the infrastructure asset returns prevail. Because infrastructure projects are financed with debt, the sector is also more susceptible to an increasing interest rate environment.
Another issue that investors need to consider is the expected holding period. Because they are equities, one should have a minimum holding period of 5 years or longer. So these securities are meant for investors who are looking at the long term (rather than day traders). Lastly, many of these infrastructure opportunities are outside of Canada and if you are planning to invest in this sector, you need to be comfortable with currency and geopolitical risks.
For those willing to assume the risks and have a longer term vision when it comes to investing, infrastructure securities can be an appropriate addition to your overall portfolio strategy. To help you minimize the risk of individual stock selection, mutual funds and ETFs specialize in this type of investment as well.