Savvy investors looking for safe, reliable long-term growth should take a serious look at including infrastructure funds in their portfolio.
According to a report from global business analysts McKinsey, almost $50trn of infrastructure investment is needed globally just to keep pace with expected economic growth.
Yet despite the rapidly growing need for new roads, railways, hospitals, sewers and electricity grids, there’s a projected global shortfall of $350bn a year if current trends continue.
Global emerging markets need an expected $30trn of infrastructure investment to meet the demands of their burgeoning economies.
Developed economies are facing a big shortfall, too. China invests more every year in the infrastructure industry than North America and Western Europe combined.
The McKinsey report Bridging Global Infrastructure Gaps highlights that:
- From 2017 through 2030, the world needs to invest about 3.8% of GDP – almost $50trn, or an average of $3.3trn a year – in economic infrastructure just to support expected rates of growth.
- Western Europe needs $12trn of investment through to 2030, the US and Canada $22trn, global emerging markets $30trn and China $29trn.
- If the current trajectory of underinvestment continues, the world will fall short by roughly 11%, or $350bn a year.
- Investment in infrastructure has declined as a share of GDP in 11 of the G20 economies since the global financial crisis
- Institutional investors and banks have $120trn in assets that could partially support infrastructure projects. Some 87% of these funds originate from advanced economies, while the largest needs are in middle-income economies.
Underinvestment of the infrastructure industry
“We found that while trillions of dollars in annual investment will be required well into the future just to keep up with expected rates of growth,” say the report’s authors, Jacques Bughin, James Manyika and Jonathan Woetzel.
“A pattern of underinvestment has produced a growing shortfall and allowed many foundational systems to deteriorate.
“Too many countries – emerging and advanced economies alike – have paid insufficient attention to maintaining and expanding their infrastructure assets, creating economic inefficiencies and allowing critical systems to erode.”
So how can the individual investor cash in on the inevitable boom as governments around the world gear up their infrastructure to cope with booming economic growth?
First let’s look at the pros and cons of investing in infrastructure. What it won’t do is make you rich quickly. Returns are sure and steady.
What it does do is provide steady, reliable growth within a portfolio geared towards the long-term. And in the long run, it may well turn out to provide better returns than a haphazard ‘win a few, lose a few’ short-term approach to investing.
So if you decide infrastructure investing is what you are looking for – perhaps as part of your pension portfolio – what’s the best way to go about it?
The first option is to buy shares in an infrastructure company, such as UK-based Balfour Beatty or Costain. However, investing in any one single company always carries an element of risk – even the biggest have stumbled.
It may not happen very often, but it only takes losing a major government contract for shares to tank.
A much safe option – as with any form of investment – is to buy into a fund that holds a basket of shares, so you spread the risk more widely.
With infrastructure funds, the vehicle may not just be investing in companies listed on the stock exchange, but also in unlisted companies, such as private equity firms that invest heavily in infrastructure.
This gives the fund much more flexibility and the potential for much greater returns, as unlisted companies are generally more dynamic and active in their management of projects than huge PLCs.
There are two main types of fund available to private investors – what are known as open-ended funds (OEFs) and closed-ended funds (CEFs). An open-ended fund is a mutual fund in which you buy units that you can legally redeem with the issuer, usually at the close of the business day.
A closed-ended fund issues a finite number of shares, which are then traded on the stock exchange and can be bought and sold at any time.
One of the biggest infrastructure funds traded on the London Stock Exchange is the FTSE250 International Public Partnerships (INPP), with a market capitalisation of £2.15bn.
Roughly half its shareholders are big institutional investors, but it also has a large number of ‘retail’ private investors.
Crucially, INPP doesn’t just rely on gains in share prices to reward investors, but also issues an annual dividend of roughly 7p per share.
“The types of listed infrastructure funds that invest directly into infrastructure assets typically provide a 4-6% yield, designed to provide a very predictable, sustainable, inflation-linked income,” said Giles Frost, CEO of INPP.
Another advantage of investing your pension pot in a fund such as INPP is the long life-cycle. INPP’s average portfolio project life is 31 years – that means if it didn’t invest in any other asset for the next 30 years, it would still generate the return promised to investors.
“The pensioners of today and tomorrow need access to dividend-generating investments to derive long-term income. That’s why infrastructure funds have become so popular,” said Mr Frost.
“Investors in infrastructure tend to be shielded from the volatility of the wider equity markets – that’s why you’ve seen infrastructure grow as an asset class in its own right because it has very long-term, visible, highly predictable returns that are so sought after, and that’s why infrastructure investment works.
“From an investor point of view, using public-private partnerships for the funding of infrastructure is mutually beneficial. The government needs the support, the technical help and the capital of the private sector, while for investors – whether they are pension funds or individuals – the goal is to find portfolio diversification and different investment ideas.
Thames Tideway Tunnel
One of INPP’s flagship projects is helping Thames Water build the Thames Tideway Tunnel – a new £4.2bn investment in the London sewer network in which INPP has a 16% stake.
The 25km long, 7.2m diameter tunnel, running up to 65 metres below the Thames, will replace the river as a ‘sewer of last resort’ when the normal sewage system can’t cope with storm overflows.
The tunnel will transport overflow sewage to a pumping station at Abbey Mills in East London before final treatment at the Beckton Sewage Treatment Works.
Other investments include schools, police stations, health centres, government offices and train rolling-stock companies.
The most common route for infrastructure investment in public projects such as schools and hospitals is via private finance initiatives (PFIs). PFIs allow governments to spread the cost of major projects by using private finance – and know-how – to build and run them.
Emerging markets ‘risky’
INPP makes a point of only investing in assets in the developed world, regarding emerging markets (EMs) as too risky – though there are plenty of funds that do if you prefer a higher risk/reward ratio.
However, there is a much greater risk of default in government contracts in emerging markets, according to Mr Frost.
“INPP isn’t necessarily seeking double-digit returns with the level of risk that that would imply. Instead, it is seeking the security of steady growth, and that comes when there is a well-established government or regulatory regime in place. Ideally long-term contracts that are in place that governments can’t just turn round and tear up.”
That received wisdom may change in the UK, however, if a Labour government is elected in 2022.
UK nationalisation threat
Investors were alarmed by the speech by Shadow Chancellor John McDonnell at the 2017 Labour Party Conference, when he appeared to imply that private finance initiatives would be brought back ‘in house’ – or in other words, nationalised.
Shares in funds and companies investing in UK infrastructure nosedived, with the Confederation of British Industry saying the policy would “send investors running for the hills”.
The Labour Party later suggested the policy would only apply to contracts affecting the National Health Service. But it has also pledged to renationalise the rail, energy and water industries, together with Royal Mail, which would have a major impact on infrastructure funds with exposure to the UK.
However, INPP's Giles Frost says there is a huge capital deficit in the UK's infrastructure needs. "The need for investment is greater than the capital available," he says. "This is what we do day in, day out – the government on its own doesn’t always have that expertise.”
He adds that INPP always takes a customer-service approach to infrastructure asset management.
The sensible infrastructure investor then, looks beyond the UK. The daily drudge of demand for utilities, transport and public services can produce solid, reliable returns – the unexciting can be a sound long-term investment.