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Categorized | Equities

The Trump factor: can infrastructure rebuild your investments?

Posted on November 18, 2016

Throughout his presidential campaign, Donald Trump promised Americans he would spend “double” that promised by his rival, Hillary Clinton, on rebuilding the country’s infrastructure.

This was the only campaign pledge he mentioned in his acceptance speech. “We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals,” said Mr Trump. “We’re going to rebuild our infrastructure, which will become, by the way, second to none. And we will put millions of our people to work as we rebuild it.”

His election, and his subsequent speech, finally persuaded markets that fiscal stimulus, or government spending, is now in vogue, while letting central banks do all the work is not. Infrastructure, as a spending project, makes sense. The US has chronically underspent on infrastructure over the years, but they are not the only ones. While the American Society of Civil Engineers has projected a $1.44tn funding investment gap between 2016 and 2025 on infrastructure, consultancy McKinsey estimates that $57tn is needed globally by 2030 to finance infrastructure projects.

Mr Trump is not the first politician in recent months to promise infrastructure spending. In the UK, Philip Hammond, the chancellor, is expected to announce a boost for infrastructure projects in his first Autumn Statement this month. Both UK and US governments expect and need the private sector to step in and help finance projects, potentially creating a large opportunity for retail investors. So what are the potential gains — and pitfalls — of putting your money into a different kind of bricks and mortar?

Broad church

Infrastructure covers the basic physical and organisational structures and facilities — buildings, roads, power supplies — needed for a society to operate, according to the dictionary definition. Investors, however, attach a few more elements to it.

“We have a set of tests where we’re looking for businesses with stable and predictable cash flows,” says New York-based Jorge Rodríguez, global head of infrastructure debt at Deutsche Asset Management. “Generally they’re monopolistic, they have high barriers to entry. Perhaps in London you can fly from half a dozen airports but you’re probably going to fly from the one closest to your house,” he said.

Beyond that, says Mr Rodriguez, subsectors include energy and utilities businesses such as those providing gas, water and waste disposal, alongside those involved in improving transport. This could be building or operating motorways, airports, seaports — “everything you can get paid for operating or making available”, said Mr Rodriguez.

But the term also includes “social” infrastructure, such as schools, hospitals and court rooms, as well as more specialised infrastructure that requires high levels of technological prowess. “That’s telecoms towers, and increasingly some folks are putting [broadband] fibre into that, also things like waste management systems, car parking and so on,” says Mr Rodriguez.

The issue for investors looking to the US for growth is that it’s impossible to tell which of these distinct asset classes Mr Trump will prioritise. “Until we know the specifics about what type of infrastructure [he] will focus on I think different stocks will be impacted,” says Dave Mazza, of US asset manager State Street.

Illiquid alternatives

At the moment, it is relatively difficult for retail investors to gain direct exposure to infrastructure, an illiquid asset class that should be held for the long term, and is better suited to pension funds, which have to meet long term liabilities.

In the UK, pension funds have piled into infrastructure following years of low bond yields, encouraged by hopes that the government reforms might make it easier for them to pool assets and invest in big projects. The problem, according to pensions consultancy Willis Towers Watson, has been a lack of clarity over the expected yield when financing large projects.

Pension funds are also reluctant to invest in projects that are yet to be built, which could face unforeseen problems during construction, pushing up costs and causing losses to investors. This leaves funds more keen on buying and selling existing infrastructure assets, rather than funding the building of new ones, says David Scott, partner at global consultancy firm Deloitte. “At the moment there is more capital pouring into the bucket of secondary investments,” he says.

An example of the fierce competition for ready-made infrastructure investments is London City Airport, which increased in value by just under £1.8bn between 1995 and 2016. While it was bought for £2bn by a Canadian-led consortium of pension funds earlier this year, Irish financier Dermot Desmond paid just £23.5m for it in 1995.

There are only really two routes for retail investors to get in on the action: through listed investment trusts, or through shares of companies focused on infrastructure. The shares can be bought directly, or held through an active or passive fund. There are a handful of equity funds holding shares in monopolistic companies that manage infrastructure, rather than build or own it, like rail operators or toll road managers.

Where to invest

To invest directly in infrastructure, rather than by buying shares in equity funds, there are seven UK-focused investment trusts. The largest is the UK-focused £2.1bn HICL infrastructure fund, managed by InfraRed Capital Partners. The fund has helped finance roads, schools and a high-speed rail line in the Netherlands. Its share price total return has been 46.3 per cent over three years, compared to a FTSE World share price return of 44 per cent.

The second-largest, the £1.7bn 3i Infrastructure fund, focuses on investing in greenfield private-public partnership projects in the UK and Europe. Its share price total return has been 64.1 per cent over three years, compared to 16.7 per cent on the FTSE Europe. That has decreased over one year to 16.5 per cent, as its share price has pushed upwards. The fund is also relatively expensive, with ongoing charges of 1.36 per cent, which is bumped up to 2.86 per cent if the performance fee is triggered.

Although the US holdings of these trusts are small at best, Simon Elliot, investment trust analyst at broker Winterflood, says US infrastructure projects “could be of interest” to some of their management boards — but warns that “any new projects are likely to be some years away from being mature enough for these funds to get involved.” The further downside is that these funds are trading on a premium to their net asset value, meaning investors will pay more for shares than the underlying assets are worth.

Steven Richards, associate director at Thesis Asset Management, says he is considering “taking profits” from the investment trusts he holds and investing the money in more globally focused open-ended funds and ETFs instead. “This will get us more global exposure,” he says. While investment trusts tend to invest directly in infrastructure projects, open-ended funds will hold equity in related companies.

The equity route

Lazard Global Listed Infrastructure Equity and Legg Mason RARE infrastructure are two such funds, both with around a third of their investments in the US. Lazard holds shares in US companies such as Norfolk Southern, and Italian company Atlantia, while Legg Mason’s fund has stakes in Sempra Energy and American Tower Corp. There is also First State Global Listed Infrastructure, the infrastructure equity fund with the highest US exposure with just under 50 per cent invested in the US.

However, wealth managers are torn on whether specialist infrastructure funds are a better bet than more general US or global equity funds. The latter may well also end up playing the infrastructure theme ahead of a hard-to-ignore “shift in economic management in the US,” says Jason Hollands, managing director at wealth manager Tilney Bestinvest.

By thinking about what might happen further down the supply chain, equity managers more broadly can still get some exposure to the asset class. “If you look at what Trump was actually talking about, it’s not necessarily going to benefit operating companies that are up and running,” says Mr Richards of Thesis. “He’s talking about building roads and bridges, so you want to look beyond ‘classic’ infrastructure and look at the supply chain.”

Energy, commodity and materials companies will all stand to receive a boost in business from any infrastructure spending. Simon Clinch, US equities fund manager at Invesco Perpetual, says he has been building up his exposure to these stocks through the year to capture an infrastructure theme. “Companies that will provide cement is an infrastructure theme, but also the sand that will be used to extract shale oil,” he says.

If Mr Trump carries through his plan to spend “double” what Mrs Clinton had promised on infrastructure, the US construction industry should see an uplift of around 30 per cent, says Mr Clinch. Even so, he warns that just as infrastructure is a long-term investment, the benefits may not show up on the balance sheets of construction companies for quite some time.

“The first time we’ll see this come through will be around 2018,” says Mr Clinch. “We’re going to take time out to understand what this means for the earnings of those companies, rather than jumping into machinery stocks or whatever.”

Even then, it’s not clear whether US stocks are the best ones to jump into. Dave Mazza of State Street points out that a company doesn’t only earn dollars just because it is a US brand — and gaining exposure to the US infrastructure game through equities is a difficult game. “There’s no perfect way,” said Mr Mazza of State Street. “If you look at [US] industrials, many of those companies have a large element of overseas exposure.”

On the other hand, non-US companies might be winning US construction contracts, and although Mr Trump is no fan of international trade deals, there’s nothing to say that this won’t continue. “I think a lot of what he’s saying is aimed at Asia and China,” says Mr Mazza. “We don’t have much information, but some of your larger European companies might benefit as well.”

What now?

For retail investors keen to invest in the UK, Mr Hammond may have something up his sleeve in his first Autumn Statement next Wednesday. The Treasury, which is keen to give retail investors access to infrastructure investing, is drawing up proposals for new “infrastructure bonds”.

Discussions have already mooted the idea of setting up a new “infrastructure bank”, modelled on the state-owned British Business Bank. Although experts told the Financial Times that the new bank would be more likely to invest in “operating assets” that had already been built and needed refinancing, it could also potentially help fund new projects. This would help both pension funds and retail investors, allowing the government to underwrite some of the risks in exchange for financing.

As for Mr Trump, questions remain about whether he will be able to pass the necessary bills by his fellow Republicans, many of whom, like Speaker of the House of Representatives Paul Ryan, are against the idea of borrowing too much money. “Is he going to get the infrastructure spend?” asks David Stubbs, global market strategist at JPMorgan Asset Management. “This is a politician that has promised everything to everyone.”

What is expected to put the wind in Mr Trump’s sails, however, is the consensus from both parties on the need to renew US infrastructure. The American Society of Civil Engineers has projected a $1.44tn infrastructure funding investment gap between 2016 and 2025.

“We’re still trying to sort through what this means,” says Mr Rodriguez of Deutsche. “I won’t make any predictions. Generally there are cautionary tales in other parts of the market but on the whole infrastructure is good news for us in the US.”

Investors looking for a cheaper alternative to an actively managed infrastructure funds could invest in a range of passive infrastructure funds on offer.

The funds, which are exchange traded funds tracking specialist indices, buy a range of infrastructure related equities according to a specially compiled index from one of S&P, MSCI, FTSE, Morningstar, or Macquarie.

S&P’s global index tracks 75 companies ranging across utilities and industrials, which make up 80 per cent of the fund, with energy stocks making up the remainder. All of the major ETF providers, including Deutsche’s x-trackers, BlackRock’s iShares and State Street’s SPDR offer funds tracking this index. Around 40 per cent of the companies held by these trackers are US companies, with the rest being European or Asian.

Rival index provider MSCI has created a World Infrastructure Index, but unlike S&P’s, is more weighted towards telecommunications. Just over 42 per cent of its constituent stocks are in telecommunications companies, with its top three holdings being AT&T, Verizon and Vodafone. For investors, this might be a less helpful play on the infrastructure theme; Mr Trump has previously committed to blocking AT&T’s $85bn bid for Time Warner, while many of the European telecoms companies in this index may suffer from the dollar exchange rate.

Morningstar has a newer and slightly different index — it is still built around an infrastructure theme, but is multi-asset and buys both stocks and debt in equal measure. Like S&P’s index, the majority of its investments are in utilities and industrials.