Infrastructure Stocks 101: Key Factors Investors Need To Know

One area of the investing landscape that is attracting plenty of attention these days is the world of infrastructure. Thanks in part to a decrepit infrastructure profile here in the United States and hopes for massive spending to correct the situation, many investors are trying to figure out which areas might be the best to play the possible trend. And even if we don’t see a big concentrated burst of spending here in the U.S., plenty will need to be doled out to keep things at the current level, while there is a general need for more infrastructure assets around the globe in the near future too.

To get some insight on this topic, I recently did a Q&A session with Chris Huemmer, Vice President and Senior Investment Strategist for FlexShares. What follows are my questions and his answers on a number of key infrastructure investing topics, which should guide you through this industry. So, definitely check it out below if you want more information on this increasingly in-focus area of the stock market world:

Eric Dutram: A lot of investors are focused on the infrastructure market these days thanks to hopes for a big Trump spending plan in this sector. Is that going to be as great for the space as many are imagining? And if it doesn’t go through, does the investment case fall apart for the infrastructure stocks?

Chris Huemmer: The demand for infrastructure is a global phenomenon and investors should avoid too heavy a focus on domestic news and conjecture. According to PWC , spending on infrastructure projects increased globally over the last decade and many countries, including the U.S., are trying to find ways to finance new projects and renovate existing assets.

One of the newest tools available to countries and municipalities are listed markets, which allow these entities to build, renovate and maintain infrastructure assets. Listed securities offer investors greater transparency and increased liquidity compared to other infrastructure alternatives.

Eric: And no matter what happens with Trump’s plans, how do infrastructure stocks fit into a portfolio? Are they more of a lower-risk/high yield play or a growth opportunity for investors?

Chris: FlexShares is focused on firmly established infrastructure assets that offer investors an innovative asset class with potentially unique benefits. Generally speaking, since these assets are essential services that everyone needs, they tend to have inelastic demand and historically good performance in down markets.

In addition, infrastructure companies operate in fairly monopolistic environments often with highly regulated pricing structures. These conditions can create predictable expenditures and reliable cash flows that allow management to offer compelling yields with historically low equity correlations.

Finally, infrastructure is often considered a long-term inflation hedge since regulated price increases are often tied to the consumer price index (CPI), or its local equivalent.

Eric: There are many types of infrastructure stocks, is there a particular area that investors need to focus on right now?

Chris: One of the best practices an investor should remember when allocating to infrastructure is to diversify their exposures as much as possible. We believe that broader exposure is better and opens up exciting investment areas like social infrastructure and communications: both typically not available in legacy indices.

By including social infrastructure (i.e. government outsourcing such as health care facilities and post offices) and communications (areas such as cell towers, data centers and wireless companies that own their networks), investors can mitigate concentrated positions into segments like utilities and energy.

Eric: So, the FlexShares ETF in this market, the STOXX Global Broad Infrastructure Index Fund (NFRA), holds stocks from around the globe. Perhaps you can discuss why some investors might want this holding profile which includes significant exposure outside of the U.S.

Chris: Spending on infrastructure is increasing on a global scale, so investors should consider how global holdings can help minimize the traditional risks associated with this asset class. Infrastructure securities often are location-specific, capital intensive assets with long lifecycles; it is often difficult or impossible to move these assets. You cannot transport a power plant, toll road or airport, so they are susceptible to changes in the political and regulatory landscape in which they are based or unforeseen risks, such as natural disasters that can impair the asset.

The best way to counter these risks is to diversify the portfolio across different geographies, sub-sectors and revenue types. This is one of the reasons we worked with STOXX to build not only a global index, but a broad representation of sub-sectors in each infrastructure segment.

Eric: Let’s also discuss why certain segments are included in the ETF. It seems heavy in energy, but also communication stocks too. The top three holdings include AT&T (T), Verizon (VZ), and Comcast (CMCSA). Perhaps you can talk about how these sorts of equities fit in a broad infrastructure play?

Chris: People are often surprised to see certain telecommunication and cable companies categorized as infrastructure. They view these companies as their cell phone or cable provider that can be replaced easily. First, it is important to note that not every telecom or cable company would qualify to be included in STOXX’s definition. What sets these companies apart is the amount of infrastructure assets each owns.

Take Verizon, for example: they have 500,000 miles of wirelines over six continents, 200 teleports in 90 countries, another 200 datacenters and numerous satellites. They just announced a deal to purchase 12.4 million miles of fiber optic cable a year to further build out their internet capabilities. It is Verizon’s ownership of these assets and importantly the revenue derived from them that qualifies the company as infrastructure.

This is a great example of what we value about STOXX’s expertise in the index design. STOXX is able to use a bottoms-up approach to identify the infrastructure assets owned by companies around the globe and tie those assets to revenue earned off of those assets. That methodology enables the index to separate wireless tower and data centers incorporated as REITs from others that are not infrastructure companies.

Eric: The fund also has a solid yield—current SEC Yields come in at around 2.6%-- is this segment one that could be troubled by additional interest rate hikes in the near future?

Some areas of infrastructure can be sensitive to changes in interest rates, which is why we advocate for a broad representation of the asset class. This is another reason to pursue a global approach. Monetary policy has remained accommodative in many international markets so a global strategy will not be as affected as a domestic-only approach.

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