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ETF Specialist

Just a Bump in the Road for the Global Infrastructure Sector?

This ETF has been battered by the decline in energy prices and weakness in emerging markets.

Dragged down in part by the slump in energy prices and in part by weakness in emerging markets, global infrastructure firms have faced pressure thus far in 2015.

And while the longer-term story of growth in global infrastructure remains intact, short-term hiccups for infrastructure firms in certain parts of the world can offer investors possible opportunities in an asset class that has solid growth potential and income-generating abilities. For investors seeking a broad, diversified, inexpensive way to invest in infrastructure firms, one suitable exchange-traded fund is  iShares Global Infrastructure (IGF).

Broadly, infrastructure firms are the private companies that construct and manage infrastructure assets such as toll roads, ports, railroads, water and wastewater systems, and power generation and distribution plants. IGF holds 76 global companies in the infrastructure industry, cutting a broad swath across the industrials, utilities, and energy sectors. (Morningstar classifies this ETF in the "miscellaneous" space.) Indeed, over the years, academics and investors alike have debated whether infrastructure truly is a distinct asset class. Many have come down on the side that the best way to characterize the industry, asset-class-wise, is that infrastructure should be defined narrowly as consisting solely of unique infrastructure assets that are not already considered part of other established asset classes, such as commercial real estate. This ETF holds firms whose assets are not necessarily included in other asset classes, along with some that very much are part of other asset classes.

Given that much of this ETF's portfolio is devoted to stable, yield-producing sectors such as utilities and master limited partnerships, IGF not surprisingly pays a healthy dividend of 4.1%. Morningstar's analysts consider IGF's dividend to be sustainable. In addition, dividend payouts should be stable as the companies held in this ETF are not especially highly leveraged and thus don't face substantial balance-sheet risk. This fund is exposed to a modest amount of cyclicality. Its five-year volatility of return of 12.1% makes it slightly more volatile than the S&P 500.

This ETF is suitable as a specialty satellite holding for investors seeking access to a basket of infrastructure firms that trade both in the United States and overseas.

Fundamental View
There always is demand for global infrastructure improvements. Spending on global infrastructure depends on local economic growth and government spending, and macroeconomic trends can affect both. Local economic growth tends to drive emerging markets' infrastructure investments. Developed-markets economies grow slower, but they still need or desire regular infrastructure upgrades. The swelling government debt loads of many developed-markets countries, however, could inhibit governments from pursuing some of those projects, which could reduce future government infrastructure spending. At the same time, a battery of private sector infrastructure firms has stepped into the void, and governments have been increasingly open to privatizing assets.

Industrials firms, largely transportation infrastructure companies, make up the biggest slice (41% of assets) of this ETF. Examples include IGF's largest holding, Transurban Group, along with Atlantia, Abertis, Groupe Eurotunnel, and Japan Airport Terminal. Many of these companies operate toll roads in Europe, Australia, and the U.S. Several firms with meaningful exposure to debt-plagued, economically ailing European countries have seen traffic volumes finally rebound after previous declines. Both Atlantia and Abertis have tried to diversify into other areas such as Latin America. Increasing Chinese auto ownership and the rise of the middle class in the Middle Kingdom should continue to boost the revenue of Chinese toll road operators in this ETF, including China Merchants Holdings, Hopewell Highway Infrastructure, and China Resources and Transportation Group.

Utilities, such as  Duke Energy (DUK),  National Grid (NGG), and  Southern (SO), make up another 40.5% of the assets of this ETF. Outside of the eurozone, electric utilities' fundamentals generally are strong with moderate payout ratios, solid balance sheets, and some high-quality growth opportunities. And in aggregate, the utilities sector's dividend yield is meaningfully higher right now than that of the 10-year U.S. Treasury yield. (Historically, during the past 20-plus years, the average spread between the two has been virtually zero.) This fund also contains some diversified utilities--which are firms that gain a material amount of operating income both from regulated distribution activities and market-based energy businesses--such as  Engie (ENGI),  Exelon (EXC), and  Public Service Enterprise Group (PEG).

Oil and gas companies also make up about 18% of this fund's assets. These include natural gas pipeline operators such as  Enbridge (ENB),  TransCanada (TRP), and  Kinder Morgan (KMI). Many of these companies generate meaningful dividends but have been pressured meaningfully by the decline in energy prices.

Portfolio Construction
IGF seeks to replicate the S&P Global Infrastructure Index, a market-cap-weighted benchmark that contains large infrastructure companies from around the world. The index includes companies involved in utilities, energy, and transportation infrastructure, including the management or ownership of oil and gas storage and transportation, airport services, highways, rail tracks, marine ports and services, and electric, gas, and water utilities. IGF follows a full replication strategy, which means it holds every company in the index. U.S.-domiciled companies make up 35% of the fund's assets, and the vast majority of the assets in this ETF are invested in companies based in developed markets. However, the firms in this ETF operate in developed and emerging markets alike. IGF holds 76 companies and has an average market cap of $15.8 billion.

Fees
IGF charges 0.47%, which is reasonable for a subsector ETF that holds a large number of firms that trade only outside of the U.S. IGF has tracked its index reasonably well over time. During the 2014 calendar year, 98.32% of the fund's dividends were qualified. That was slightly below the levels of previous years. During 2013, 99.38% of IGF's dividends were qualified, while during 2012, 92.7% of IGF's dividends were qualified.

Alternatives
Several other ETFs are devoted to global infrastructure. The largest ones are FlexShares Stoxx Global Broad Infrastructure (NFRA) and SPDR S&P Global Infrastructure (GII). Since May 2013, the SPDR fund actually has tracked the same index as IGF and as a result also holds 76 companies; however, it has a lower price tag (0.40%). (Prior to May 2013, GII had tracked an index managed by FTSE.) At the same time, the SPDR fund has a fraction of IGF's assets and is much less liquid. The FlexShares ETF, which costs 0.47%, holds more companies (more than 150 in total) than IGF and GII. In addition, the index that NFRA tracks takes a more expansive definition of infrastructure companies than the iShares fund and the SPDR, including holding telecommunications companies such as  AT&T (T) and  Verizon (VZ), trash haulers like  Waste Management (WM) and  Waste Connections (WCN), health-care providers such as HealthSouth (HLS) and  Tenet Healthcare (THC), and North American railroads like  Union Pacific (UNP),  Canadian National Railway (CNI), and  Kansas City Southern .

In recent years, several other new infrastructure ETFs have launched, but none has meaningful levels of assets or liquidity.

There also are several actively managed open-end funds devoted to global infrastructure. Morningstar does not cover any of these funds. The largest is Russell Global Infrastructure (RGISX) (1.22% expense ratio). Another is Deutsche Global Infrastructure (TOLSX) (1.18%). IGF's performance has matched the Russell fund in the three-year period ended Aug. 31, 2015 but has trailed the return of the Deutsche fund. During the past year, IGF has slightly outperformed the two funds.

Robert Goldsborough does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.