Infrastructure has long been a problem and a strong investment theme in the emerging market space. According to OECD estimates, a growing middle class and the need to move exports has created the need for $71 trillion dollars in infrastructure spending worldwide in the next 20 years. Despite the historic need for build out of roads, electricity grids, and sanitation systems, infrastructure spending in the emerging world has always been a risky bet for investors. Utilities are a highly regulated sector and suffer from price controls and political risk. Infrastructure spending for the construction and materials sectors depends heavily on government financing, a volatile funding source often accompanied by an excruciating level of red tape. Investor interest in infrastructure has boomed and there have been several exchange traded funds created to capitalize on the build out. While I am overall neutral on the sector within the EM space, it is an interesting theme with great potential for growth.
Goldman Sachs, in a recent report, estimates the aggregate gap between the BRICs and the G6 in electricity, telecoms, and rails as approximately $10 trillion. This is more than twice the BRIC’s current GDP, and the closing of this gap could last 25 years. The four countries are similar only in their need for increased infrastructure spending. Using World Bank data, India appears to be the least developed, lagging the other three in mobile phones, per capita electricity consumption, and access to sanitation facilities. Russia leads the four in mobile phone usage, per capita electricity consumption, and access to water and sanitation facilities. The five-year cumulative growth for the four emerging nations in power consumption per capita to 2008 was 14.0%, 54.8%, 23.8%, and 14.1% for Brazil, China, India, and Russia respectively. This compares with a growth of just 3.0% in the OECD countries. Despite a more urbanized population in Brazil, China’s growth has allowed it to surpass the South American country in terms of electrical consumption per capita.
The number of internet users per capita within the BRICs has experienced significant growth but still lags the developed world significantly. As with other metrics, India is the standout laggard while Russia is the most developed of the four. Though growth over the five years ending in 2009 in the OECD countries has been strong with a cumulative 22.4% increase, average growth in the BRIC nations is almost seven times higher. Growth in the number of internet users per capita in the four countries was 86.5%, 236.2%, 115.1%, and 176.4% in Brazil, China, India, and Russia respectively.
The explosion in the use of mobile phones within the region has been impressive over the five years to 2009, with usage in Russia eclipsing that of the OECD average. China and India lag significantly, largely as a result of their percentage of rural population relative to the group. Growth for the five years to 2009 was 93.8%, 86.0%, 451.9%, and 93.8% in Brazil, China, India, and Russia.
In addition to the immense need for increased spending, companies within the sector can rely on a portion of their revenues even during harsh economic times. Since a portion of government spending must be budgeted to maintain sanitation and transportation network, the infrastructure space is somewhat insulated from economic volatility. High barriers to entry and often nationalistic favoritism to domestic companies help to argue the case for investment.
Brazil’s build out to host the World Cup in 2014 and the Olympics in 2016 could still drive significant gains in the sector within the country. Thus far, bottlenecks and poor planning have plagued the country’s hopes to be ready. Of the estimated $20.9 billion needed in infrastructure spending, only about $3.3 billion has been invested as of April 2011. To help with the drive, the government has begun a process of privatization for three of the 66 state-owned airports. The three airports: Sao Paulo, Campinas, and Brasilia account for approximately 43% of the estimated airport infrastructure spending needed.
Within the BRIC space the selection for infrastructure exchange traded funds is limited, though a little more than 30 funds target infrastructure in general. Emerging Global Advisors manages three funds targeting India, Brazil, and China individually. The three funds are managed to concentrate on the sectors within infrastructure specific to each country. This explains the relatively higher exposure to financial services in the Chinese and Indian funds compared with that of the Brazilian fund. All funds hold significant exposure to materials, industrials, and technology companies. The EGShares INDXX China Infrastructure Fund (CHXX) has a market cap of $16.5 million and trades at a trailing price-to-earnings of 14.1 times. The largest industry exposures within the infrastructure space include: construction & materials (26.9%), real estate investment & services (24.2%), industrial metals & mining (13.4%), and industrial engineering (9.0%). The fund’s dividend yield is the highest of the three at 5.5 percent.
The EGShares INDXX Brazil Infrastructure Fund (BRXX) has a market cap of $75.4 million and trades at a trailing P/E of 13.6 times. The largest industry exposures within the infrastructure space include: electricity (25.0%), fixed-line telecom (18.4%), utilities (10.8%), and industrial transportation (10.2%). The fund’s dividend yield is lower, but still impressive at 3.5 percent.
The EGShares INDXX India Infrastructure Fund (INXX) has a market cap similar to that of the Brazilian fund at $72.3 million and trades at a trailing P/E of 18.2 times. The largest industry exposures within the infrastructure space include: electricity (19.8%), construction & materials (17.6%), mobile telecom (14.2%), and industrial engineering (13.6%). The fund’s dividend yield is the lowest at 1.5 percent.
The PowerShares Emerging Markets Infrastructure Portfolio (PXR) is the largest of the four funds with a market cap of $168.2 million and trades at a leading P/E of 12.3 times. The fund holds equities in a diverse selection of countries including: China (13.3%), South Africa (11.3%), Taiwan (10.2%), Brazil (9.2%), Hong Kong (7.1%), Indonesia (6.7%), Malaysia (6.6%), Russia (5.3%), Chile (4.5%), and the United States (4.3%). The fund is fairly evenly split between industrials (50.7%) and materials (46.5%) though exposure to some of the more developed markets dilutes some of the emerging market benefit. The concentration of holdings in materials, and lack thereof in utilities means the fund is more closely correlated with commodity prices. I appreciate the benefit of diversification across different countries, an especially important benefit when investing in the volatile EM space, but would augment investment in the broader fund with smaller investments in the country specific funds. A 15% allocation to each of the China, India, and Brazil funds along with a 55% allocation to the broader fund would increase exposure to Chinese, Indian, and Brazilian infrastructure to approximately 21.7%, 15.0%, and 19.6% respectively while lowering the exposure to developed markets like Taiwan and the United States to 5.1% and 2.2%.
Huge budget deficits and systemic risk in the financial system could depress the returns for the global infrastructure funds like the iShares S&P Global Infrastructure Index (IGF). The fund has a market cap of $491.3 million and trades at a leading P/E of 15 times. The majority of the fund's holdings, greater than 60%, are held in companies based in the developed world. For those wanting to play the emerging market build out but less positive on infrastructure in general, the fund may provide a good opportunity for a long-short.