Take Caution - Infrastructure ETFs

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Includes: GII, IGF, TOLZ
by: Almeida Investment Management

Summary

Investors should be aware of underlying holdings in infrastructure ETFs.

Infrastructure ETFs have benefited from a weak dollar.

Interest rate risk will effect these ETFs going forward.

Coming into the 4th quarter I often find myself reflecting on how the year has played out. Just this time last year we all had one thing on our minds. The election left us all concerned about what the outcome could mean for us as individuals, both professionally and personally. Meanwhile, Wall Street enthusiasts remained laser-focused on what the results could mean for the market. As divisive as the election may have been, one common theme everyone could agree one was infrastructure. Both Clinton and Trump campaigned on infrastructure spending, and ultimately Trump was recognized as the true champion with a long history of real estate development and construction project experience. And just like that, overnight, the "Trump Trade" received the green light, with infrastructure being the primary theme. Those who bought Infrastructure ETFs have done particularly well. However, investors should be aware of what they are holding in those ETFs and why they have performed so well this year.

Here are three ETFs you should specifically review if your intentions were to get behind infrastructure spending as a theme, including theyear to date (as of 9/26) of each:

  • The ProShares DJ Brookfield Global Infrastructure ETF (NYSEARCA:TOLZ) - 13.22%
  • iShares Global Infrastructure ETF (NYSEARCA:IGF) - 17.63%
  • SPDR S&P Global Infrastructure ETF (NYSEARCA:GII) - 17.66%

If you are patting yourself on the back for scoring a lay-up on these I would think again. This wasn't as easy as 1,2,3…

  1. Trump is elected
  2. Put money behind infrastructure
  3. What's the easiest way to get exposure? Bingo! I'll buy an ETF

And for everyone who followed this mantra, it's time to reevaluate this trade.

"Trump Trade"

First, let's take a look at whether or not these vehicles were in fact used for the "Trump Trade". The largest of the three, IGF which has about $1.7 billion in assets, saw record fund flows following the election until year end 2016. Approximately $319 million poured in from the day after the election until 12/31/16. Compared to the rest of the year, from January 1st up until November 8th, IGF had a net inflow of $42.5 million. Both TOLZ and GII saw similar trends relative to the size of their funds. TOLZ experienced net outflows up until the election, then $3million of net money through the end of the year. Not a small amount considering the size of the fund is only $40million. As for GII, it eclipsed its 2016 total net inflow before the end of April this year.

The popularity and demand for these securities immediately following the election cannot be ignored. The real question is - have they performed according to this idea of benefiting from who was elected? Even more importantly, what should we expect from them in the year to come?

The Dollar

The truth is an argument can be made that Washington's turmoil may have helped boost these funds rather than the anticipation of a large infrastructure package. Why is that? Returns for each of these ETFs can be explained primarily by dollar weakness this year, and not because of infrastructure expectations from our administration. A weakening dollar was driven primarily by a rebound in Europe and a low probability of fed rate hikes priced into the market for most of the year. Even more, uncertainty around tax policy, health care, the debt ceiling, and now geopolitics have had the FX market betting against policy change for the better part of the year. Strategists from Nomura, Bank of Singapore, and Deutsche Bank have all expressed that negative returns on the dollar cannot solely be explained by interest rate differentials, but sustained weakness must also be attributed to political instability. Year to date (as of 9/26) the US dollar index, DXY, is down approximately 9%.

Breaking Down TOLZ, IGF, & GII

So, why would a weak dollar benefit these ETFs? When diving down into the contents of these funds, IGF, GII, and TOLZ all have non-US stock exposure of 65%, 63, and 50% respectively. Not exactly your rebuild America portfolios. Considering each portfolio is not currency hedged, it's easy to see that performance of each can swing quite significantly with price changes in the dollar. The bulk of their international exposure includes investments in Europe, Canada, the UK, and Australia. All of which have appreciated significantly against the dollar this year.

Exposure by country as of 9/26/2017

ETF

Europe

U.K.

Canada

Australia

IGF

28%

5%

10%

10%

TOLZ

17%

6%

15%

5%

GII

30%

5%

6%

10%

Currency Performance vs U.S. Dollar as of 9/26/2016

Euro/$

Pound/$

Cad/$

Aussie/$

+12%

+9%

+4%

+9%

Considering IGF and TOLZ had substantial exposure to the Euro, up 12% vs the Dollar this year, these two funds performed best. When plotting the US Dollar Index performance versus all three ETFs the picture becomes quite clear.

*Chart Depicts Price Return Only, Excluding Dividends

Risks Ahead

Interest rate risk may not have exactly been your first thought when buying infrastructure ETFs, but it's certainly the biggest risk that lies ahead for these funds. First, through the currency exposure that rests in most of their investment assets lying outside the United States. After Janet Yellen's recent comments that "We should be wary of moving to gradually" when it comes to interest rate hikes, may suggest that we continue on a path of raising and normalizing rates. Increased rates could attract more investment in US fixed income securities from investors and increase demand for dollars. Dollar strength would be a drag on performance for IGF, TOLZ, and GII.

Second, increased rates could also drastically affect prices in each fund given their sizable allocations to utility stocks. In a rising rate environment, utilities can trade similarly to bonds given their income focus. Keeping an eye on rates and the pace of rate increases will be critical as IGF, TOLZ, and GII have a 39%, 35%, and 42% allocation to utility stocks.

All said and done, investors should know what they and own and why they own it. When it comes to infrastructure ETFs as a Pro-America trade, this is not it. With high international exposure and exchange rate risk, the focus of these funds is truly global and not US-centric. Those who got in based on election results coincidentally managed to benefit from sizeable returns. Now, at year end, they would be wise to reconsider their reasons for holding these funds going into 2018.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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