Simply spreading your investments across a smattering of asset classes with the idea that diversification should automatically produce a positive result is an approach that's maybe a little too similar to a roll of the dice. A portfolio of poorly performing investments may be diversified, but it's not necessarily a path to higher risk-adjusted returns or to the sort of stability one might hope could survive bouts of volatility. For investors hunting for classes to diversify into, Wilson Magee, Director of Global Real Estate and Infrastructure Securities, Franklin Templeton Real Asset Advisors, and co-manager of Franklin Global Listed Infrastructure Fund, has one word: infrastructure.
Portfolio Manager, Franklin Global Listed Infrastructure Fund
Global listed infrastructure focuses on assets that provide essential services which are necessary for populations and economies to function, prosper and grow. The asset class invests in transportation such as rail, airports (but typically not aircraft), water utilities, electricity utilities, communications infrastructure (for example, cell phone towers), toll roads and ports. Infrastructure includes essential energy services, such as transport and storage but not exploration and production.
We think one of the most attractive potential benefits of global listed infrastructure is its relatively stable revenue streams, a feature that has become particularly appealing to volatility-weary investors. Coupled with an attractive historical dividend yield, this asset class demonstrates underlying defensiveness in cash flows. Part of the appeal of the asset class stems from the essential nature of the assets themselves, which have relatively monopolistic and regulated positions, high barriers to entry, stable demand and long duration assets with defined revenue streams. Such characteristics can provide the asset class with a degree of protection from the business and economic cycles that is not available to equities. This is why, we think, we've seen infrastructure investments deliver continued earnings growth and stability during the course of the global financial crisis.
We believe global listed infrastructure as an asset class is poised for strong growth. Three important growth themes for infrastructure worldwide support this view. The first is aging infrastructure, which in many developed markets needs to be repaired, replaced, or upgraded. One estimate suggests that by 2020 the US needs to spend US$3.6 trillion1 to repair aging infrastructure, and globally the estimates are closer to US$57 trillion2.
The second growth-supporting theme is global population growth, particularly in emerging markets where urbanization and an expanding middle class are likely to drive rapid growth in demand for new infrastructure. Globally, the middle class is expected to grow by 800 million people from 2005 through 20153. From 2015 through 2025, another 1.5 billion people are expected to be added to the middle class4. A rising middle class will require infrastructure to support the increased demand for essential services and transportation of goods and products.
And third, with a combination of increased fiscal spending and economic distress, a significant gap in government infrastructure spending could occur during the next 20 years in both the developed and emerging markets. In our view, this could create an enormous potential opportunity for private listed infrastructure investment.
These growth themes indicate to us that prospects for global listed infrastructure investment look promising, and the asset class looks attractive when compared with other asset classes, such as global equities generally, US equities, and bonds.
Don't Forget Dividends
An important component of the global listed infrastructure asset class has been a history of dividends. As represented in the chart below, the annualized dividend yields for the period ending 6/30/13 for infrastructure companies compares favorably to those of some other asset classes5.
Historically, dividend growth has also outpaced inflation,6 having grown annually over the last 10 years7, and the compound growth rate of 11.3%8 annually has easily outpaced inflation. However, we do not expect dividend growth rates in the future to be as high as they have been in the past. Long-term inflation-linked contracts are a frequent characteristic of many infrastructure investments, often supporting both dividend stability and growth.
Here, and There, and There, and There
In our view, investors looking for diversification will find that global listed infrastructure can provide a diversified source of income, as well as attractive growth potential. While diversification doesn't guarantee profit or protect against loss, infrastructure as an asset class offers global opportunities spanning North America, Europe, Asia Pacific and Latin America. We are particularly enthusiastic about the prospects for US energy infrastructure and for Latin America, where we expect significant growth could be possible.
Regardless of where the opportunity is, we believe a bottom-up stock selection process is paramount to long-term investment success and that infrastructure can provide investors looking for both potential income and appreciation an attractive solution.
What Are the Risks?
All investments involve risks, including possible loss of principal. The Franklin Global Listed Infrastructure Fund's investments in infrastructure-related securities involve special risks, such as high interest costs, high leverage and increased susceptibility to adverse economic or regulatory developments affecting the sector. The fund's investments in utility company securities, if purchased for dividend yield, involve additional interest rate risks.
When interest rates have risen, the stock prices of these companies have tended to fall. Thus, as the prices of utility company stocks in the fund adjust to a rise in interest rates, the fund's share price may decline. By focusing on an industry or group of industries, the fund carries much greater risk of adverse developments and price movements in such industries than a fund that invests in a wider variety of industries. Special risks are associated with foreign investing, including currency rate fluctuations, economic instability and political developments. The risks of foreign investing may be greater in developing or emerging markets. Investors should be comfortable with fluctuations in the value of their investment, as small and mid-sized- company stocks can be volatile, especially over the short term.
Smaller or relatively new or unseasoned companies can be particularly sensitive to changing economic conditions, and their prospects for growth are less certain than those of larger, more established companies. Derivatives, including currency management strategies, involve costs and can create economic leverage in the portfolio which may result in significant volatility and cause the fund to participate in losses (as well as enable gains) on an amount that exceeds the fund's initial investment. The fund may not achieve the anticipated benefits, and may realize losses when a counterparty fails to perform as promised. These and other risks are described more fully in the fund's prospectus.
1. Source: American Society of Civil Engineers, 2013 Report Card for America's Infrastructure.
2. Source: McKinsey Global Institute and McKinsey Infrastructure Practice, Infrastructure Productivity: How to Save $1 Trillion a Year (January 2013).
3. Source: Middle Class Data: Homi Kharas, Brookings Institution, 2012. Population Data: "World Bank: Health Nutrition and Population Statistics: Population estimates and projections." West and Asia region definitions: Surjit S. Bhalla, Second Among Equals: The Middle Class Kingdoms of India and China, May 2007.
5. Source: FactSet, as of 6/30/13. © 2013 FactSet Research Systems Inc. All Rights Reserved. The information contained herein: (1) is proprietary to FactSet Research Systems Inc. and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither FactSet Research Systems Inc. nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Sources: S&P 500 Index and S&P Global Listed Infrastructure Index. Copyright © 2013, S&P Dow Jones Indices LLC. All rights reserved. Reproduction of the S&P 500 Index and S&P Global Listed Infrastructure Index in any form is prohibited except with the prior written permission of S&P. S&P does not guarantee the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions, regardless of the cause or for the results obtained from the use of such information. S&P DISCLAIMS ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. In no event shall S&P be liable for any direct, indirect, special or consequential damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with subscriber's or others' use of the S&P 500 Index and S&P Global Listed Infrastructure Index. Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI. Source: Barclays Global Family of Indices. © 2013 Barclays Capital Inc. Used with permission. Source: FTSE EPRA/NAREIT Developed TR USD Index. "FTSE®" is a trade mark of the London Stock Exchange Group companies, "NAREIT®" is a trade mark of the National Association of Real Estate Investment Trusts and "EPRA®" is a trade mark of the European Public Real Estate Association and all are used by FTSE International Limited under licence. The FTSE EPRA/NAREIT Developed TR USD Index is calculated by FTSE. Neither FTSE, Euronext N.V., NAREIT nor EPRA sponsor, endorse or promote this product and are not in any way connected to it and do not accept any liability. Indexes are unmanaged, and one cannot directly invest in an index. Past performance is not indicative of future results.
6. Source: Bloomberg, Franklin Templeton Real Asset Advisors and Bureau of Labor Statistics. Global Listed Infrastructure Dividend Growth per share is represented by annual growth in the dividends per share of the 52 members of the S&P Global Infrastructure Index as of March 28, 2013, for which dividend data is available dating back to 2003. Many of the companies in the index have been publicly traded for less than a decade. Source: S&P Global Listed Infrastructure Index. Copyright © 2013, S&P Dow Jones Indices LLC. All rights reserved. Reproduction of the S&P Global Listed Infrastructure Index in any form is prohibited except with the prior written permission of S&P. S&P does not guarantee the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions, regardless of the cause or for the results obtained from the use of such information. S&P DISCLAIMS ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. In no event shall S&P be liable for any direct, indirect, special or consequential damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with subscriber's or others' use of the S&P Global Listed Infrastructure Index. Indexes are unmanaged, and one cannot directly invest in an index. Past performance is not indicative of future results.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.