Why Infrastructure ETFs Are Overrated

Early in 2007, a prospective client informed me that he would not be placing his $1,000,000 portfolio with my company, Pacific Park Financial. He explained that another Registered Investment Adviser specialized in leveraged emerging market ETFs and that the firm’s performance was amazing. I challenged the individual to better understand daily compounding versus annual compounding, though ultimately, I recognized the infatuation for what it was.

Less than two years later, I received a phone call from a familiar voice. My one-time prospect expressed regret for selecting the other asset manager. He ruefully described losing $800,000 of his $1,000,000 savings as well as his marriage. And “…would I be willing to manage his small account ($200k) with 100% emerging market stock ETFs?”

As much as I would have liked to have helped, I needed to decline. I could not in good conscience contribute to the notion that gambling on emerging markets alone was the proper direction for any individual or family.

Some infatuations fade, though. More money has been exiting emerging market stocks, bonds and currencies than at any other point in the last two years. And while it would obviously be cavalier to use leveraged long emerging stock ETFs now, it is certainly reasonable to revisit themes like rapid economic development in up-n-coming nations.

Indeed, the folks at Morningstar recently recommended the iShares Global Infrastructure Fund (IGF). They describe this exchange-tracker as a low-cost income generator for tapping an underrepresented sector; that is, a 4% yield is a phenomenal payment for holding a number of premier firms engaged in handling toll roads, railroads, potable water, waste-water and electricity.

The problem with Morningstar’s assessment is threefold. First, there may always be a need for infrastructure improvement, but that does not guarantee profitable suppliers willing to fill the demand. The same case has been made previously with respect to food via “millions of more mouths to feed.” Yet, agribusiness funds like Market Vectors Agribusiness (MOO) have struggled since their inception.

Secondly, Morningstar is ignoring the potentially damaging impact that rising rates could have on an ETF with heavy exposure to utilities and master limited partnerships. While central banks around he world are likely to keep interest rates contained for a while longer, ETFs like IGF simply do not respond well to rapid spikes.

Third, the price-ratio between IGF and the iShares All-World Index Fund (ACWI) demonstrates a persistent lack of momentum. Seeking “alpha” is dandy when alpha actually exists; in this instance, I’m not certain that the asset class is distinct, nor am I confident that it adds value up and above the “beta” provided by ACWI.

Granted, if you choose to fall in love with infrastructure as a concept — if you choose to marry a theme the way the aforementioned prospective client chose emerging market exclusivity — iShares Global Infrastructure Fund (IGF) is probably better than the infrastructure alternatives. I agree with the folks at Morningstar that IGF is probably more desirable than SPDR FTSE/Macquarie Global Infrastructure 100 (GII). For the time being, however, infrastructure investments are likely to drag on portfolio performance… not benefit the exchange-traded fund enthusiast.

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.