Correlating Infrastructure

Includes: IGF, MIC, PHO
by: Roger Nusbaum

A reader left a comment in which he pasted information about water and infrastructure that took a skeptical tone about both. I took the reader's intention as simply pointing out the other side of the investment case.

I'll take water first. I may not have been clear with this before as I have disclosed PowerShares Water Resources (NASDAQ:PHO) as an across the board holding many times over, but I have never thought of water as not being equity exposure. I add PHO as part of the the allocation to the industrial sector which is the largest sector of PHO.

Water is a theme and I think it is both important and investible, but still equity exposure. If the bullish case for water plays out then it is reasonable to expect the stocks that are exposed to outperform the broader market. If you agree you probably have some exposure and if you disagree you don't.

I still don't know what to make of the Canadian hydro funds I wrote about a couple of months ago. I don't know that they are a separate asset class unto themselves but maybe a part of some unnamed asset class that lumps in high yielding, exchange traded vehicles that can be volatile. The plane leasing stocks might fit in as could the Macquarie Infrastructure Trust (NYSE:MIC) that I have written about and own.

MIC might fall under a couple of different headers which leads us to infrastructure and whether it is its own asset class.

In yesterday's post I noted that Mohamed El-Erian broke it out like it was a distinct asset class and I gave that a whoa champ, like in those very funny Ping Iron commercials. When a new account comes in, I build a spreadsheet that lists all of the big SPX sectors and include an extra "sector" that I just label as other;  I include MIC in "other" because over time it has marched to its beat versus SPX.

In looking at iShares Infrastructure ETF (NYSEARCA:IGF), which I own for a few clients, you will see it correlates very close to SPX, so I think of that as part of the industrial sector, what I hope will be a way to add value in that sector but still, industrials and not something separate.

Part of the knock on industrials in the reader's comment was that infrastructure correlates to GDP (so a reason why infrastructure is not distinct from equities). That contention was not supported but it seem reasonable to me; an infrastructure stock is likely to correlate to the GDP of its country. However there are countless times where GDP does not correlate to the equity market like in China right now, and if you believe that equities turn up before the economy (this is supported historically) then you would be skeptical that GDP correlates to equity prices.

Of course it is not that simple. At times equities and GDP probably do correlate and at other times they do not. I don't think this line of thought is compelling in either direction.

Unfortunately there is no single answer. Personally I do not think there is any argument to be made for engineering stocks being distinct from equities. Toll roads can be a mixed story. Look at a chart of Paris Rhin Rhone [ARR.PA] compared to iShares France (NYSEARCA:EWQ). They appear to correlate going back quite a ways, but last December when EWQ rolled over, ARR.PA held up much better, so maybe the toll road in France is different.

Contrast that with Zhejiang Expressway [0576.HK], this is an H share, versus the Shanghai Composite [^SSEC on Yahoo Finance]. Starting in 2007 it caught every bit of the mania-induced run-up and has moved in lock-step down since the peak last fall. So maybe for China, toll roads are not different.

Canada has been different, Australia has been different, Portugal has not been different, as some examples. So it depends, and of course looking back guarantees nothing about future results. For each one you can a draw different conclusion. One toll road may have nothing to do with the country and simply be a way to diversify the portfolio. You might come to find that a different toll road might be a great proxy for its home country. If you are going to dabble you need to be willing to explore this aspect of the investment.

What about airports? The correlation between the Auckland Airport [AIA.NZ] and the NZ 50 Index [^NZ50] seems to ebb and flow with no discernible pattern (the controversial bid from the Canadian Teachers Union hasn't helped). Aeroports de Paris [ADP.PA] seems to diverge from EWQ quite a bit so maybe that is different. Actually as I look at a few more airports the correlation seems to be low in most instances.

The big macro is that money is being spent and will continue to be spent on toll roads, airports and the other aspects of infrastructure not covered in this post. Regardless of whether you think it is a distinct asset class (and I think the conclusion of this post might be that is not the best way to approach it) it makes sense to have a moderate exposure to something where money must be spent.