Friday, June 25, 2010

Underhill, The Handbook of Infrastructure Investing

Infrastructure has been a hot investing topic for some time. Emerging markets are building it out, developed markets are working at fixing or upgrading it. In The Handbook of Infrastructure Investing (Wiley 2010) Michael D. Underhill has collected a set of papers that look at opportunities for venture capitalists, private equity, institutional investors, and even the lowly individual investor.

I’m going to confine myself to opportunities for the individual investor. Even though the chapter on valuing the Pennsylvania Turnpike might be interesting (and in fact, having driven this road more often than I’d like to remember, I read this piece first) it doesn’t have much relevance for those of us who aren’t at the top of the financial food chain.

But first, a sobering report card on U.S. infrastructure issued in 2009 by the American Society of Civil Engineers. Aviation D, bridges C, dams D, drinking water D-, energy D+, hazardous waste D, inland waterways D-, levees D-, public parks and recreation C-, rail C-, roads D-, schools D, solid waste C+, transit D, wastewater D-. Not exactly Ivy League material!

So, aside from infrastructure ETFs and the standard energy, utilities, and engineering stocks, what else is out there for the individual investor? And what can we reasonably expect from infrastructure investments?

Underhill’s own paper “What Is Listed Infrastructure?” suggests that infrastructure investments offer “long-term stable cash flows that have the potential for inflation hedging. In addition, infrastructure assets tend to have high barriers to entry, providing monopoly-like features. . . . They behave somewhat like a bond with their stable cash flows and provide investors the ability to participate in capital appreciation or equity upside potential as the underlying assets appreciate in value.” (p. 164) Between November 30, 2001 and December 31, 2008 (I assume that the starting date is linked to the launch of the S&P Global Infrastructure Index and hence isn’t arbitrary) global infrastructure stocks outperformed global stocks by a wide margin (10.86% vs. 0.83%). Their annualized volatility, however, was only slightly better: 14.95% vs. 15.31%.

For investors who want to invest in traditional energy, master limited partnerships are an option. The folks at Chickasaw Capital Management (four authors) provide a thorough review of MLPs. Currently there are 78 publicly traded energy MLPs. They’re structured along the lines of REITs, paying quarterly cash distributions. Between January 2000 and December 2008 the Citigroup MLP Index trumped every other significant index (equities, commodities, real estate) with a low correlation (between 24% and 37%) to every one of them. Drawdowns weren’t pretty, but on balance they were less than those of the other indexes.

This book is not a must-have, but for those who are seeking to diversify their portfolios it shines a light on a path often not taken.

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