Wednesday, 23 July 2008

Adding Infrastructure as a Separate Holding in a Portfolio?

Back in June, when I posted about the Canada Pension Plan Investment Board's investing approach, I discovered that it has significant holdings of infrastructure investments to provide inflation protection and portfolio diversification. Infrastructure consists of physical structures that support society - airports, seaports, water systems, electricity grids, toll roads, gas distribution, telecommunications networks, schools, hospitals, prisons.

So I asked myself why and how I as an individual investor should add infrastructure as another component of my portfolio.

The Why's?
Potential Portfolio Diversification
The possibility that infrastructure could reduce my overall portfolio volatility and/or improve returns through having its returns uncorrelated with other holdings seems to have some merit. In the April 2008 presentation Global Infrastructure - A "New" Alternative Asset Class by Edward Keating of Lazard Asset Management LLC, chart 20 shows the up and down 3-year rolling correlation of infrastructure with global equities and with global bonds. The low correlations (say 0.3 or less) from around 2000 to 2003 would have been quite worthwhile. Since 2004, the correlations have been climbing to 0.4 or higher, meaning much less portfolio diversification benefit.

In the May/June 2007 issue of the Journal of Indexes, Tony Rochte's Infrastructure article shows on page 3 the correlations from 2002-06 for infrastructure against a number of asset classes like US equities, non-US equities, commodities, US bonds and US T-bills. The equities correlations are high while the rest are low. The time series isn't very long so the strength of the conclusion is weak.

Rochte goes on to show that a portfolio with infrastructure as a separate asset would have done better than one without in his study period, especially during the time of market decline in 2000-02. Maybe now would be a good time to do the numbers again to see if the relationship repeats itself.

Overall, there seems to be a fair diversification benefit.

Potential Higher Risk-Adjusted Returns
This aspect is a puzzle since both the above materials (Lazard chart 19 and Rochte page 2) show that the risk-adjusted returns for infrastructure, as calculated in a higher Sharpe ratio, are significantly higher than other equities. One would expect that market forces would bring the return-risk ratio into line with other types of investments.

Ways to Invest - ETFs, Funds and Companies
There appears to be about 70 to 100 major infrastructure companies around the world, many of whose shares can be bought in North America, whether they are based here or abroad. The easiest way to find them is to look at the composition of various infrastructure indices (and these indices seem to be proliferating as the infrastructure fad is growing):
- FTSE Macquarie Global Infrastructure Indices (MGII) (heaviest weighting in utilities)
- S&P Global Infrastructure
- Dow Jones Brookfield Global Infrastructure Indices (new since July 2008)
- NMX Infrastructure Indices (focus on companies with a perceived monopoly)

There are already a number of mutual funds, most as usual actively managed, and we can be sure the bandwagon will get more and more crowded as the investment industry looks for the "next big thing" after the sub-prime meltdown following the tech meltdown (I think of this as bubble rotation). A few examples: Renaissance Investments Global Infrastructure Fund (Canada), First American Global Infrastructure Fund (USA), Caninfrastructure Mutual Fund (India). One company, the Macquarie Infrastructure Company (NYSE: MIC), is a large diversified conglomerate that operates in several different infrastructure businesses and almost looks like a fund itself.

There are two main passively-managed ETFs aligned to one of the above indices available through US markets:
IGF - iShares S&P Global Infrastructure Fund (guess which index it tracks) - MER of 0.48%
GII - SPDR FTSE/Macquarie Global Infrastructure 100 - MER 0.6% and 80% weighting in utilities

An actively-managed closed-end fund has popped up in Canada - the Macquarie NexGen Infrastructure Corporation (class A shares are traded on the TSX under symbol MNF). It's performance has so far (since March 2007 inception) been disappointing - down 21% vs the benchmark minus 3.4%.

Last October, Roger Nusbaum wrote about MIC, GII and a number of infrastructure companies in Infrastructure Funds Flub Stress Test on His Correlating Infrastructure on Seeking Alpha is also worth reading.

The Criticism
A sobering and well-argued counter-argument to treating infrastructure as the next must-have part of a portfolio is The Skilled Investor's post The Birth of Yet Another Darn Asset Class - Infrastructure.

Bottom line for me:
- I do own, at lower MER cost ranging from 0.07% to 0.17% (in VIT, VGK, VPL and XIU) vs the higher MERs of the index ETfs, all or virtually all of the main publicly traded infrastructure companies;
- thus I get the diversifying effect of those companies, only it is hidden within my existing holdings
- I already have enough headaches balancing my overall portfolio across my various accounts - regular, RRSP/RRIF, LIRA - without adding another holding

Some people may wish to play the greater fool game of musical chairs and ride the likely infrastructure fad in hopes it becomes the next bubble and try to sell out in time but for now I'll look at other things to improve my portfolio.

1 comment:

Anonymous said...

Here's another take on infrastructure as an asset class:

The authors believes that rise of infrastructure as a new asset class is just another ploy by the fund industry to suck more money from investors. He also has a beef with the high cost of new funds used to capture this asset class.

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