Presented by Bisdorf Palmer, LLC

WHAT IS INFRASTRUCTURE?

Infrastructure refers to facilities and systems that serve a region or nation. It typically refers to the technical structures that support a society, such as roads, water supply, sewers, power grids, and communications. Although many of the services in this domain have long been provided by the government, public budget shortfalls and rapid expansion have opened opportunities for private sector investment and profit. Examples of investable infrastructure assets include:

• Communications: Cell towers, data centers, fiber networks, and satellites
• Midstream energy: Oil and gas pipelines, storage facilities, and export terminals
• Transportation: Airports, railroads, seaports, and toll roads
• Utilities: Electric, gas, renewable power, transmission lines, waste, and water

WHY INVEST IN INFRASTRUCTURE?

Infrastructure is a real asset that shares investment characteristics with real estate, including contractual revenues, inflation-linked revenues, relatively stable cash flows, and above-average income compared with other sectors. Utilities, for example, have other unique attributes, including high barriers to entry, monopolistic characteristics, and regulated cash flows because some assets are regulated by government agencies.

Benefits Associated with Infrastructure

• Defensive characteristics. Infrastructure offers the potential for a more defensive risk-and-return profile compared with the broader equity markets due to relatively stable cash flows generated from essential assets.
• Income. Infrastructure owners and operators typically distribute a higher portion (i.e., payout ratio) of the cash flows to investors compared with other sectors, given higher cash flow visibility associated with long-term contracts.
• Inflation protection. Some infrastructure assets have inflation-linked revenues, which can mitigate inflation risk. In addition, income growth (e.g., dividends) offers the potential to keep pace with inflation.

Risks Associated with Infrastructure

• Event risk. Natural disasters, such as earthquakes, floods, hurricanes, and wildfires, can damage or destroy infrastructure assets, along with posing a liability risk to infrastructure owners and operators. PG&E (a utility company), for example, filed for Chapter 11 bankruptcy in 2019 following liability connected to wildfires in Northern California.
• Interest rate risk. Infrastructure assets can be sensitive to interest rates because of debt financing and long-duration assets that are more sensitive to changes in market discount rates from a valuation standpoint. In other words, a higher discount rate can have a more negative impact on valuations for long-duration assets when future cash flows are discounted back to present value. U.S. cell tower REITs, for example, tend to be sensitive to interest rates.
• Political and regulatory risk. Governments can potentially change tax rates, regulations, and other policies that can directly affect infrastructure assets from an investment standpoint. Furthermore, some governments may have the authority to restructure contracts or reclaim infrastructure assets from companies at prices that are unattractive to investors.

Investment Considerations

Given these risk factors, funds can provide diversified exposure to infrastructure companies and the various asset types compared to investing in individual companies. The investment strategies and portfolios can vary widely among funds from a geographic and sector standpoint. Core and core-plus strategies, for example, focus on owners and operators of infrastructure assets. Other strategies further out on the risk spectrum typically have higher exposure to assets or industries that are much more sensitive to the economy (i.e., cyclical), such as businesses involved in materials, construction, development, engineering, and equipment. In addition, some strategies provide exposure to emerging markets, which may have heightened political and regulatory risk.

• Core. Core strategies tend to focus on infrastructure assets located in developed markets. Core assets are characterized by regulated or contractual revenues with visible cash flows, typically enabling high payout ratios to investors in the form of dividends or distributions.
• Core-plus. Core-plus strategies lie further out on the risk/return spectrum than core. Core-plus infrastructure assets are located mainly in developed markets as well, but cash flows from the underlying assets may be more sensitive to economic activity. Midstream energy and transportation assets, for instance, may be more sensitive to fluctuations in demand or volumes.

Types of Funds

• Mutual funds. Active mutual fund managers in the infrastructure category typically invest globally to gain access to a wider universe of assets, including airports, seaports, and toll roads because these transportation assets are less commonly owned by U.S. publicly traded companies. Some active managers focus on core and core-plus assets, while limiting or excluding exposure to cyclical industries and emerging markets, offering the potential for a more favorable risk-return profile.
• ETFs. The product landscape can be more limited for ETFs compared with mutual funds for the infrastructure category. One distinction is that U.S.-focused infrastructure strategies are more widely available for the ETF structure. Passive infrastructure ETFs, however, may have higher exposure to cyclical industries as well as emerging markets, which can potentially result in a higher risk profile.
• Nontraded products. The investment strategies and underlying infrastructure asset exposure can be similar for nontraded products compared to liquid funds. For instance, some products focus on core and core-plus infrastructure assets. A key difference is that the underlying investments may consist mainly of direct infrastructure assets or private companies as opposed to publicly traded companies. As such, there are liquidity constraints at the product level and the valuation methodology may be based on periodic appraisals, rather than public markets.

Role in a Portfolio

An infrastructure fund could complement a real estate allocation because both asset classes share investment characteristics. Infrastructure is a younger asset class than real estate, and the significant capital needed to upgrade the infrastructure landscape globally could create growth opportunities for infrastructure funds.

Infrastructure offers the potential for lower volatility and lower downside risk compared with the broader equity market; however, the asset class is likely to underperform the broader equity market during a period of strong equity market returns. From a sector standpoint, utilities represent the largest portion of the investable universe, with secondary sectors including energy, industrials, and real estate. Some infrastructure funds may have slight overlap with real estate funds; communications assets, for example, are commonly owned by infrastructure and real estate funds.

This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation. Investments are subject to risk, including loss of principal. Some investments may not be appropriate for all investors, and there is no guarantee that any investment will be able to sell for a profit I the future, or that any investing goal will be met. Past performance is no guarantee of future results. Diversification Investing in alternative investments may not be suitable for all investors and involves special risks, such as risk associated with leveraging the investment, utilizing complex financial derivatives, adverse market forces, regulatory and tax code changes, and illiquidity. There is no assurance that the investment objective will be attained.

Mutual funds involve risk, including possible loss of amount invested. An Exchange-traded funds (ETFs) are subject to market volatility, including the risks of their underlying investments. They are not individually redeemable from the fund and are bought and sold at the current market price, which may be above or below their net asset value.

Mutual funds and ETFs are sold by prospectus. Please consider the investment objectives, risks, charges and expenses carefully before investing. The prospectus, which contains this and other information, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Authored by the Investment Research team at Commonwealth Financial Network®.

© 2023 Commonwealth Financial Network®.