An Income-Generating Asset Class Underrepresented In The ETF World

| About: iShares Global (IGF)

By Robert Goldsborough

In an environment where interest rates are near zero and investors are hunting for yield, one income-generating asset class that has been gaining attention from U.S. investors involves infrastructure. Broadly, infrastructure firms are the private companies that construct and manage infrastructure assets, such as toll roads, ports, railroads, water and waste water systems, and power generation and distribution plants.

For investors seeking a broad, diversified, and inexpensive way to invest in infrastructure firms, we recommend iShares S&P Global Infrastructure Index (NYSEARCA:IGF). This exchange-traded fund holds 75 global companies in the infrastructure industry, cutting a broad swath across the industrials, utilities, and energy sectors, although Morningstar categorizes this ETF as being in the industrials space. Indeed, over the years, academics and investors alike have debated whether infrastructure truly is a distinct asset class. Many have come down on the side that the best way to characterize the industry, asset-class-wise, is that infrastructure should be defined narrowly as consisting solely of unique infrastructure assets, which are assets not already considered part of other established asset classes, such as commercial real estate. This ETF is filled with firms whose assets are not necessarily included in other asset classes.

Given that much of this ETF's portfolio is devoted to stable, yield-producing sectors such as utilities and master limited partnerships, IGF not surprisingly pays a healthy dividend of nearly 4%. We consider IGF's dividend to be sustainable, as it grew even during the financial crisis. In addition, we expect dividend payouts to be stable as the companies held in this ETF are not especially highly leveraged and thus don't face substantial balance-sheet risk. What's more, this fund's cyclicality is not high, in part because of its exposure to utility companies. The fund's five-year volatility of return of 20.1% makes it slightly less volatile than the S&P 500 Index.

This ETF is suitable as a specialty satellite holding for investors seeking access to a basket of infrastructure firms that trade both here and overseas.

Fundamental View
No one would dispute that there's always demand for improvements to the world's infrastructure. Spending on global infrastructure depends on two things: local economic growth and government spending. Both dynamics can be at risk based on certain macroeconomic trends. Local economic growth, especially in emerging-markets countries, can drive infrastructure investments. In developed-markets nations, by contrast, local growth by definition is slower, but regular infrastructure upgrades often are necessary and desired. However, many developed-markets countries' increasingly growing government debt loads will necessarily constrain governments from pushing forward with some of the infrastructure programs that they may want. That may mean lower infrastructure spending from governments in the future. At the same time, a battery of private operators of infrastructure assets has arisen to fill the void, and governments have been increasingly open to the notion of privatizing assets.

Industrial firms, largely those operating in the transportation infrastructure world, make up the biggest slice of this ETF, soaking up close to 41% of assets. Examples of transportation infrastructure firms are toll-road developer and operator Transurban Group (NYSE:TCL), which is IGF's single largest holding, Atlantia SPA (NYSEMKT:ATL), Abertis, Groupe Eurotunnel (GET), and Japan Airport Terminal.

Electric utilities make up another 21% of the assets in this ETF. Some large electric utilities held in this ETF include Duke Energy (NYSE:DUK), National Grid (NYSE:NGG), and Southern Company (NYSE:SO).

Several other large industries represented in this ETF are oil and gas companies, which make up about 21% of this fund's assets. These include natural gas pipeline operators such as Enbridge (NYSE:ENB), TransCanada (NYSE:TRP), and Kinder Morgan (NYSE:KMI). Finally, diversified utilities, such as GDF Suez, Exelon (NYSE:EXC), and Entergy (NYSE:ETR), make up the remaining 17% of IGF's assets.

Although Morningstar's equity analysts do not cover enough of the companies in this ETF for us to be able to develop an aggregated valuation of this fund, IGF has a meaningful tilt toward the energy sector, which our analysts believe is meaningfully undervalued relative to other sectors.

Portfolio Construction
IGF tracks the performance of the S&P Global Infrastructure Index, a market-cap-weighted benchmark that contains large infrastructure companies from around the world. The index includes companies involved in utilities, energy, and transportation infrastructure, including the management or ownership of oil and gas storage and transportation, airport services, highways, rail tracks, marine ports and services, and electric, gas, and water utilities. IGF follows a full replication strategy, which means it holds every company in the index. U.S.-domiciled companies make up 30.5% of the fund's assets, and the vast majority of the assets in this ETF are invested in companies based in developed markets. However, the firms in this ETF operate in developed and emerging markets alike. IGF holds 75 companies and has an average market cap of $14.5 billion.

IGF charges 0.48%, which is reasonable for a subsector ETF that holds a large number of firms that trade only outside the United States.

The only other global infrastructure ETF that trades is very small. SPDR FTSE/Macquarie Global Infrastructure 100 ETF (NYSEARCA:GII) tracks an index containing global infrastructure companies. However, GII has very thin trading volumes, so watch bid-ask spreads carefully.

A global fund offering some of the same exposure--but with no weighting in utilities and energy--is iShares S&P Global Industrials (NYSEARCA:EXI), a global industrials ETF that charges 0.48%. Over the past five years, the performance of IGF and EXI has been 89% correlated.

Other ETF providers currently have ETFs covering certain niches of global infrastructure in registration. For instance, Global X Funds has submitted paperwork to the SEC seeking permission to create a passively managed, proposed toll roads and ports ETF, while ProShares has filed with U.S. regulators seeking permission to create a passively managed infrastructure ETF. Investors interested in that particular slice of the market should keep an eye on those proposed launches.

There also are several open-end funds devoted to global infrastructure that investors might want to consider. The largest of these is Russell Global Infrastructure (RGISX) (1.22% expense ratio). Other good-sized funds include Nuveen Global Infrastructure (FGIYX) (0.99%), Morgan Stanley Global Infrastructure (UTLDX) (0.86%), DWS RREEF Global Infrastructure (TOLSX) (1.24%), and Forward Global Infrastructure (KGIYX) (1.23%).

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