New Infrastructure ETF From SSGA: A Closer Look

Bloomberg News has the scoop on an ETF for a new asset class. Well, 'new' except for the hundreds, if not thousands, of large institutional investors who have already implemented exposure to the infrastructure sector.

Details of the fund
The article states that the fund will track the Macquarie Global Infrastructure 100 Index. It also specifically mentions the following sub-sectors:

• Telecommunications companies
• Electricity companies
• Water companies
• Gas-distribution companies

For anyone outside of Australia, the name Macquarie is synonymous with nothing but infrastructure investing. A Google search on this index leads you to this FTSE website that covers the Macquarie Global Infrastructure Index Series which according to the site is composed of:

• Macquarie Global Infrastructure Index
• Macquarie Global Infrastructure 100 Index
• Macquarie Global Infrastructure Hedged Index
• Regional infrastructure indices: Australasia, Japan, North America, Europe and Asia Pacific/Japan/Australia/New Zealand
• Sector indices: global oil & gas pipelines, global transportation services, global telecommunications equipment and global utilities with subsectors of global electricity, multi-utilities, gas distribution and water.

A lucky break: If you check out the “Constituents” subpage, it actually provides details for only one index which happens to be the one in question, the Macquarie Global Infrastructure 100 Index.

We find that nearly half of the positions are from the US with the internationals consisting primarily of EAFE plus Canada. For those looking for some BRIC exposure, I only see three Brazilian positions. The Bloomberg article refers specifically to “companies in countries including the U.S., Australia, U.K., India, Brazil and Russia”.

However, contradictory to the article, I see nothing in terms of direct exposure to India or Russia on the constituent listing. Nothing in China. Likely, the Bloomberg article implies that many of the companies in the index have significant exposure to these countries, but it could also be an oversight.

Infrastructure – New hot sector?
Another hot sector justifying the pumping out of a new ETF? Not so in this case. Let’s look at a few existing closed end funds in the sector -- I’ve limited them to those also from Macquarie:

Macquarie Infrastructure Company (MIC)

Macquarie/First Trust Global Infrastructure/Utilities Dividend & Income Fund (MFD)

Macquarie Global Infrastructure Total Return Fund (MGU)

OK, I lied. These funds are near their highs. Don’t pretend like you’re shocked. I, like many others, have been talking about this type of occurrence for a while. However, in reality, I don’t see this as a “hot” sector that is out of line in terms of overvaluation. Certainly, we’re not anywhere close to a mania in this area.

It’s true, large and sophisticated institutional investors (mega-pensions with over $100 billion in assets) are buying ports, toll highways and other large scale infrastructure projects, but I believe there is much more in the pipeline available for all other investors as various global economies are modernizing to something more similar to what we have.

Global exposure and the search for yield
Take the most often cited story of this decade: India and China. India’s “golden quadrilateral” super-highway and its associated network of roadways are in their early stages. If India is to be the US of the future, then what is to stop India from having a highway system similar to that of the US? Break out your atlas or give your globe a spin and you’ll see that, geographically speaking, India is about a third the size of the US. It’s not small and there is a large (understatement here) group of middle class workers who will want to experience the freedom of driving.

What about China? Like South Korea in 1988, there will be an explosion of tourists who will come after the Olympic games to explore China. China is already working on expanding its airports and highways for the expected traffic. They’re going to need it and more… aside from Beijing and Shanghai, most of China looks more like a truly developing country rather than a major cosmopolitan center. Although the prospects for an ambitious highway complex as in India may not be developed soon, there are so many other areas of infrastructure where China will need significant amounts of investment.

In terms of recent product development, State Street Global Advisors is on a bit of a roll with this ETF and their recent SPDR® MSCI ACWI (All Country World Index) ex-US ETF (CWI). Kudos to them on bringing a key and missing alternative asset class on line.

To some observers, infrastructure is an industry class just like technology or financials. I think that the institutions see infrastructure as an asset class because it is different in that it’s a bit like private equity in many cases, but more importantly it provides one thing that they, especially pension funds need: flow. Flow, meaning cars on a toll highway, planes passing through an airport, oil flowing through a pipe, data traveling through fibre optic cables. To them, this flow equals income.

If you go to the above charts online via bigcharts.com, you will be given some statistics along with the charts. For example, from the chart for MGU, we can calculate the 12-month price return as just over 30%. However, this does not include the 12.5% yield (according to BigCharts.com), paid through quarterly distributions.

Infrastructure is an area that interests me so I get updates directly from Macquarie. A December 6, 2006 press release mentioned the following:

NEW YORK, December 6, 2006 – Macquarie Global Infrastructure Total Return Fund Inc. (NYSE: MGU) (the “Fund”) yesterday declared its regular quarterly distribution for the period ending December 31, 2006 of $0.40 per share.

Based on the Fund’s net asset value of $29.37 and New York Stock Exchange closing price of $27.37 on December 5, 2006, the $0.40 per share distribution is equal to an annualized distribution rate of 5.45% at NAV and 5.85% at market price respectively.

The $0.40 per share quarterly distribution reflects a distribution policy of the Fund intended to provide shareholders with a relatively stable cash flow. This policy may be changed or discontinued without notice to investors.

In addition, the Fund declared a special annual distribution of $0.50 per share relating to additional short term capital gains earned on the sale of portfolio securities during the year.

This is just one example, but in the search for yield, infrastructure delivers. In this environment, this is not only true for the mega institutions, but for all investors. A significant global economic slowdown could put a dent into many sectors including some of those that may be classified under infrastructure, but only for a relatively short time. Infrastructure is one of those “must haves” in life. Again, kudos to SSGA.

To be perfectly honest, SSGA, like Barclays Global Investors, is more known for relatively low cost, broad exposures with their ETFs. If I were a betting man, I would have guessed that something as unique as this new infrastructure ETF would have been brought to market by one of the new and smaller players like PowerShares, Van Eck or Claymore.

I’ve been thinking lately that maybe the ETF industry would start to diverge where the big providers (SSGA, BGI, Vanguard) would go “Wal-Mart” and stick to broad, low cost exposures while the newer entrants would focus on higher margin niche products. I guess not. Everybody’s got to watch their back. Just the way I like it.

Comments

[User 39448:]

Hi Richard,
Great article with good analysis. Do you think the 'search for yield' is somewhat frothy right now? Given tax breaks and a market hungry for yield, aren't some of these traditional infrastructure plays bid up right now? Most importantly, retail investors need to determine how secure the dividend flow on these types of stocks is. Investing in shippers, for example, solely for their yield is dangerous -- in spite of paying out a large % of their earnings to shareholders, they notoriously slash dividends when the market softens and for tax reasons.

2007 Jan 28 10:38 AM

[Chamois16:]

Good article, Richard, but surely you consider Hong Kong part of China! My hangup with the MacQ 100 Index is that it largely a utility index and thus somewhat redundant to other CEF/ETF in that space. Also redundant is some respects to MLP and Trust funds such as FMO, KYN, BGR et al

The new SSGA fund though is a serious contender for many portfolios; thanks for highlighting its inception!

2007 Jan 28 11:32 AM

[Vladimir Se...:]

According to ETF connect, MFD and MGU both have seen significant reduction in the discount in the last 6 months. In fact, it almost feels like that had something to do with oil prices coming down, but that's just a feeling i have, nothing to back that up.
I personally avoid funds that change outrageous fees (as high as 3.5% according to ETF connect) unless i can get in when discount is at it's peak.
So based on those high fees alone, new ETF in this sector should do well relative to those funds. Thanks for the heads up!
I'm not sure how well the sector is going to do if there is significant volatility in the energy sector though. We've seen some large % moves in energy in the last 6 months and could see more of that in the near future.

2007 Jan 28 12:21 PM

[Richard Kang1:]

ZM: The search for yield still has a ways to go as long as central banks keep the trend going and rates stay relatively low. Everyone knows about Japan's ZIRP but the small spread between developed and developing country interest rates is another thing to consider. You see this global search as investors move from place to place looking for yield. Sometimes it's an opportunistic grab, but in other cases opportunities are taken away without much notice. Canadian income trusts and recent changes by the Canadian government on tax treatments of these is a good example and you have also mentioned shippers as another example. In terms of fund offerings (whether ETF or not), you see a lot of new product development with some form of dividend or value bias. WisdomTree is a good example. In fact, all the non-market cap weighted index funds (equal weighted, fundamental weighted, etc.) are all means to play this tilt ... whether designed that way or not.
I know that many of the very largest pension funds have made significant investments into infrastructure but what about the many more smaller institutions? Are their investment consultants planning or currently implementing similar shifts in allocation? It wouldn't surprise me at all, especially as many investors (including hedge funds) look globally and especially in the emerging markets.
Bottom line with pensions is that the recent few years of good returns hasn't been strong enough to offset the simultaneous and more significant increase on the liability side of their balance sheet. Modern processes such as "liability driven investing" will drive further interest into areas like infrastructure for these types of extreme scale portfolios.
Will all this lead to some sort of overdone condition for value stocks and sectors such as infrastructure. Of course that's possible but this "ebb and flow" sine curve is part of the game. That's not for me or one person to comment on but for the market to comment on with their dollars invested.

C: You're totally right with Hong Kong. I only wonder what proportion of the total fund will be invested in these 4 HK positions. I hear a lot about the major airport, nuclear power plant, highway and water projects in China and these are found in the general mass media like the Economist or CNN so you'd think that a major ETF or CEF like this would somehow participate in a big way. But when you think about it, likely it's the private investment that is more effective in China since it's probably the best way to get in considering the various hurdles (corruption) related.

VS: Good comments but I'll focus on the fact that you've mentioned energy twice in your comment. Yes, further to my comments on significant product development in the ETF space related to the commodity complex, including both traditional and alternative energy, this could be another play especially if energy infrastructure (including utility companies) comprise a significant proportion of the fund. You have to wonder if the rules of diversification have to be thrown out the window in today's environment. You want to participate in energy and the commodity sectors if you believe more in Jim Rogers versus his naysayers. You want to have exposures to emerging markets because of the strong demographic story, higher overall growth numbers and beyond. You want to get into infrastructure for reasons I've posted above. But all are so highly correlated and probably correlated more than you think with what you already have in your portfolio. There is the school of thought that is very anti-diversification and most (rather all) hedge funds should be thinking this way if they are mandated to be beta-neutral. In other words, they don't build portfolios based on Markowitz MPT. Thus, they do NOT add investments based on their low correlation to other positions in the portfolio. The question is how many investors are thinking opportunistically in this manner? And if we're talking about significant numbers, will this create greater volatility on the upside as well as when the market eventually goes down? VIX is still cheap at just over 11.

2007 Jan 28 04:10 PM