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Overview

Infrastructure is an important component of economic growth and integral to the functioning of modern society, spanning transportation, commodities (e.g. the electric grid and interstate pipeline system) and data (e.g. communication towers and data centers). However, despite its importance, global infrastructure spending is lower than what is required for current population growth rates. Investors considering infrastructure as an investment theme may benefit from renewed appetite by governments globally to address this gap, though it is critical to understand the various global and regional drivers at the global, U.S. and emerging markets levels. In short, we believe governments globally could use infrastructure investment as a way to counter the negative economic consequences of the coronavirus, providing short-term employment opportunities and long-term productivity gains.

The case for infrastructure investing

In general, investing in infrastructure can offer potential long-term returns, income generation and diversification. Characterized by long-lived real assets with useful lives typically greater than 20 years, stable cash flows and inelastic demand, infrastructure is a real asset with appealing investment characteristics. In a low-yield environment we believe the investment characteristics of infrastructure may become even more appealing — particularly as we see both public-private partnerships and governments commit to improving and building assets.

In addition, we observe four trends that could support the asset class both in the short term, and over the longer term:

Attractive valuations. Year-to-date through April 7th, infrastructure has broadly underperformed the relevant broader markets on a price return basis. Emerging Market infrastructure has underperformed by the most — down 14 percentage points more than the MSCI EM Index (Source: Bloomberg). Over this same time period U.S. Infrastructure underperformed the S&P 500 Index by 11 percentage points and global infrastructure underperformed the MSCI ACWI by nine percentage points. Similarly, forward price-to-earnings multiples of the infrastructure indexes declined more rapidly year-to-date than their relevant benchmarks, implying underperformance relative to the benchmark. In our view, this reflects the underperformance of cyclicals and investor preference for defensive investments at this stage in the economic cycle. We believe this may be overdone, potentially allowing room for infrastructure related investments to outperform going forward, as evolving industry and economic dynamics pave the way for increased spend.

Infrastructure has underperformed YTD

Line graph showing price performance of various infrastructure indexes versus broad market indexes.

Source: Bloomberg as of April 7, 2020; Indexes used: NYSE Factset U.S. Infrastructure Index, S&P Global Infrastructure Net Total Return Index, S&P Emerging Markets Infrastructure Net Total Return Index, MSCI ACWI Index MSCI Emerging Markets Index, S&P 500 Index. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

A global need for infrastructure spending. A report penned by the McKinsey Global Institute in 20191 estimated that the world needs to invest approximately $3.7 trillion per year on average through 2035 into roads, railways, ports, airports, power, water and telecom. Emerging markets will require two-thirds of the expenditure.

Governments globally have approached infrastructure investing with various levels of urgency: China, for example, spent 9.3% of GDP on infrastructure between 2010 and 2016, as compared to Brazil’s 2.1% and India’s 4.7%1. But, Oxford Economics2 estimates Asia (in particular China and India) still accounts for 54% of the global infrastructure needs through 2040, with China representing 30% of global infrastructure needs, followed by the Americas at 22%.

Increased spending in China. Despite China’s significant investment in infrastructure to date, in absolute dollar terms the country still requires substantially more investment, second only to India. Roughly 50% of China’s investment need is for new investment, with the remaining 50% on replacement. Oxford Economics has estimated $26 trillion will be spent in China between 2016 and 2040. Although this may represent a smaller percentage of GDP than it has in the recent past, potential coronavirus stimulus packages excluded, this still represents an anticipated 30% of global spending.

Bipartisan support for boosting U.S. infrastructure spending. The most recent American Society of Civil Engineers Infrastructure Report card gave the U.S.’ cumulative infrastructure a grade D+, with underwhelming grades across 15 of the 16 categories. In addition, the Brookings Institute estimates annual real infrastructure spending fell by ~$10 billion from 2007 to 2017, from $450.4 billion to $440.5 billion. In fact, federal spending for infrastructure has remained stagnant at roughly 2.5% of GDP over the last several decades, excluding the short-term boost in 2009 and 2010 as a result of the American Recovery and Reinvestment Act.

U.S. Public Spending on Transportation and Water Infrastructure as % of GDP, 1956-2017

Line graph showing infrastructure spend as percentage of GDP.

Source: Congressional Budget Office, using data from the Office of Management and Budget, the Census Bureau, and the Bureau of Economic Analysis.

However, over the last few years infrastructure spending has garnered increased bipartisan attention, particularly given the short-term economic output and long-term productivity gains associated with such spend. Discussions around fiscal stimulus measures to counter the economic impact of the coronavirus pandemic have centered on a possible $2 trillion infrastructure package. According to researchers at the IMF3, increased public investment of 1% during a recession decreased the unemployment rate by 0.5% after one year and 0.75% after four years. President Trump has touted the current low interest rate environment as a prime opportunity to push the long-debated infrastructure bill over the finish line. Legislators are expected to debate this issue in Q2 2020 as the next round of fiscal stimulus talks get underway.

Longer-term themes supporting infrastructure. There are two secular themes behind infrastructure: (1) upgrading aging infrastructure systems in developed markets and (2) demographically fueled growth in new infrastructure associated with higher standards of living in emerging markets. These two themes cut across each of the five megatrends, or the structural long-term trends transforming our economy and society, including: technology breakthroughs, demographics and social change, rapid urbanization, climate change and emerging global wealth. In our view megatrends offer long-term investors a potential opportunity to realize outsized performance results. With infrastructure hitting on each of these megatrends, it presents investors with a unique way to benefit across multiple structural advances underway.

One area specifically that warrants watching is clean energy. President Obama signed the American Recovery and Reinvestment Act of 2009, which included $90 billion towards clean-energy related investments across the supply chain. This investment, one of the largest in these sectors in U.S. history, paved the way for substantial growth in solar electricity generation, wind generation, and other technologies. In our view, clean energy could be included in the next U.S. infrastructure package, i.e. the next fiscal stimulus package responding to the coronavirus’ negative economic consequences, as politicians weigh future energy resiliency and evolving economic demands.

Flows

Year-to-date, as of April 7th, flows into U.S. listed infrastructure ETFs represent 7% of their AUM, or nearly $400 million (see chart below). Over the previous four years (2016-2019) infrastructure related AUMs of U.S. listed ETFs increased 188%, or $4 billion. The vast majority of these flows have been directed into global infrastructure funds, which also have the largest AUMs vs. U.S. and Emerging Market infrastructure funds. Global infrastructure funds represent 99% of total AUM. (source: Markit)

Flows into U.S. listed Infrastructure ETFs YTD

Line graph showing ETF flows YTD.

Source: U.S. listed ETF flows. Markit as of April 7, 2020. Flows are subject to change.

Conclusion

We believe the current underperformance of infrastructure related funds — across global, emerging markets and U.S. — presents long-term investors with a potential opportunity to benefit from increased government spending in this space. Investors looking for a regional approach should consider focusing on both the U.S. and China. These two nations have significant fiscal stimulus policy ability and the appetite to engage in infrastructure spending as a way to jumpstart GDP growth while addressing long-term structural needs.

Christopher Dhanraj
Director, Head of iShares Investment Strategy
Elizabeth Grenfell contributed to this article.
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