Global Infrastructure: What's The Best ETF?

• By Murray Coleman
• On 3:00 am EDT, Tuesday September 1, 2009

Editor's note:This is an excerpt of an article that originally ran in the July edition of the Exchange-Traded Funds Report. The complete story can be accessed by ETFR subscribers here.

As the world digs itself out of recession, government-backed projects are funneling billions of dollars into creating new bridges, roads and tunnels.

That has some investors considering hopping on the $787 billion American Recovery and Reinvestment Act’s bandwagon. More than $80 billion of that total is earmarked for building, repairing and maintaining infrastructure projects across the country.

It’s not surprising that infrastructure has emerged as a popular theme for many investors. However, a few caveats need to be considered. For one, the seemingly huge outlay in public funds is going to be spread out over many years. By many estimates, actually spending all of that money could take a decade or more. While that figures to provide a steady financing stream, it also translates into a somewhat diluted initial impact.

Also, the range of projects that has been green-lighted is enormous, as are the sheer number of projects being proposed. In fact, reports continue to circulate over heavy lobbying by politicians and public interest groups vying to win bids for pet projects.

An International Trend?

While the bulk of infrastructure contracts wait to be awarded, China has been moving even more aggressively to stimulate its economy. In fact, sovereign wealth funds around the world have been busy doling out billions more to revive markets outside the U.S., leading to talk of an international infrastructure boom.

“The stimulus efforts we’re seeing in the U.S. aren’t exactly going to turn out to be a second coming of the New Deal,” said Robert DeHollander, an engineer-turned-financial-adviser, referring to Franklin Roosevelt’s efforts to fight the Great Depression.

The Greenville, S.C.-based portfolio manager at Ameriprise Financial notes that spending on infrastructure projects in the U.S., while impressive, still represents a fraction of the overall reinvestment act’s total budget.

“The growth of infrastructure projects is something that’s just one driver of future economic growth,” said DeHollander. “We consider it as a long-term trend that isn’t going to be isolated to U.S. markets alone.”

For those reasons—and the fact that traders have been anticipating increased infrastructure spending since last year’s U.S. presidential elections—DeHollander is easing into exchange-traded funds focusing on the still-evolving space.

“We think that emerging markets will outpace developed markets over the next decade,” he said. “A big part of that will be the improvement of bridges, roads and all sorts of infrastructure in developing countries.”

Earlier this year, DeHollander started buying the PowerShares Emerging Markets Infrastructure ETF (NYSEArca:PXR - News). He prefers it compared to the iShares S&P Global Infrastructure Index Fund (NYSEArca:IGF - News), the other broadly diversified international infrastructure ETF.

“More than half of PXR’s portfolio is investing in raw materials producers who are positioned to benefit right away from shovels-in-the-ground projects,” said DeHollander. “A lot of those are commodity-sensitive companies.”

PXR is also big into industrials, and light (almost none) in utilities, which play a large role in many infrastructure ETFs. PXR’s underlying index defines infrastructure as companies involved in the actual building of projects. “We’re trying to get to the core of infrastructure in emerging markets,” said James Pacetti, an analyst at S-Network Global Indexes, which created PXR’s benchmark. “In those markets, industrial machinery and metals manufacturers as well as materials- and mining-related companies represent a lion’s share of the infrastructure projects taking place.”

The S-Network benchmark is broken into three different market-capitalization bands. Each cap gets a third of the overall weighting. Within those bands, companies are weighted according to traditional market-cap sizes. At least a third of their revenues must come from infrastructure projects.

IGF takes a much different approach to global diversification in the field of infrastructure. The ETF’s index provider, Standard & Poor’s, divides the sector into three component groups:energy, transportation and utilities. When it rebalances once a year, the weightings are adjusted to 40% each for utilities and transportation, with 20% going to energy.

“When we were looking at creating an infrastructure index, there was a pretty valid criticism that existing indexes were too dominated by utilities,” said Srikant Dash, global head of research and design at S&P’s index services group.

He argues that ignoring utilities leaves out a big part of that market. But a key differentiation point between the two most diversified infrastructure plays is that IGF’s index is heavily skewed toward developed markets. Dash says over time, it typically should average about an 85% tilt to that side.

By contrast, PXR had only two sizable developed markets in its portfolio in mid-June. Those were the U.S. at about 7% and France at 4.7%.

“The term infrastructure has been used very loosely,” said Dash. “It has grown to become an all-encompassing term. But different index-based products take on different risk profiles depending on how they weight sectors and markets.”

Different Angles On Infrastructure

For indexing purists, there’s another option. That’s the SPDR FTSE/Macquarie Global Infrastructure 100 ETF (NYSEArca:GII - News). Like the iShares global fund, it’s predominantly focused on developed markets. But unlike IGF, the SPDR ETF holds around 90% of its assets in utilities. And that’s the way it should be for index-based infrastructure portfolios, according to Jerry Moskowitz, managing director of FTSE Group Americas.

“If people want to look for diversification within infrastructure, there are only two ways to do it—the way we’ve chosen or to put an artificial cap on utilities that doesn’t capture the real makeup of the sector,” he said.

The more diversified infrastructure plays—PXR and IGF—also have segments devoted to business services. Those are mainly engineering and construction companies. Investors who would prefer to focus on infrastructure from that angle have a fourth pure-play option:the First Trust Global Engineering and Construction Index ETF (NYSE Arca:FLM).

It’s another predominately developed markets portfolio, with the United States at about 25%, and Japan at nearly 20%. It typically will have between 10–15% weighting in emerging markets companies. Either way, all engineering and construction firms included in the benchmark must have at least 70% of their revenue generated from public works projects.

Buzz up!