With recession-battered governments around the world looking for ways to stimulate their economies, infrastructure projects are front and centre. China, for instance, recently announced a US$586-million infrastructure package to boost its economy.

This emphasis on infrastructure projects could mean solid investment opportunities for your clients over the medium to long term. Infrastructure funds tend to provide safe, stable cash flow, and the recent drop in their unit prices as a result of global economic woes provides a good entry point.

“I believe infrastructure will continue to grow in importance and as a focus of investors,” says Dan Bastasic, manager of the $5.4-million Mackenzie Universal Global Infrastructure Fund and vice president, investments, withMackenzie Financial Corp. of Toronto.

The Mackenzie fund is one of a small number of global infrastructure funds available to Canadian investors.

“[Investing in infrastructure] is beneficial for everyone,” Bastasic adds, “has low correlation with other asset classes and very high historical risk-adjusted returns.”

The outlook for infrastructure development is strong. Not only is there huge demand from rapidly industrializing emerging countries but infrastructure in the developed world also needs a great deal of costly maintenance and upgrades.

Says Patricia Fee, portfolio manager with I.G. Investment Management Ltd. in Dublin and manager of the $31.1-million Investors Global Infrastructure Fund: “U.S. infrastructure [spending] requirements over the next five years are estimated at US$1.5 trillion, while the price tag in the emerging world is almost three times as high at US$4.4 trillion.”

But, she cautions, the global economic slowdown and credit crunch could delay some infrastructure projects as project originators put off spending or have trouble finding financing.

Richard Elmslie and Nick Langley, investment directors and senior portfolio managers with Sydney-based infrastructure investment manager RARE Infrastructure Ltd., agree that difficulties in accessing capital will restrain infrastructure spending in the private sector. But, they suggest, government-backed infrastructure projects won’t face the same difficulties.

RARE — which manages the $53-million Renaissance Global Infrastructure Fund, sponsored by CIBC Asset Management Inc. of Toronto — has surveyed the companies in which the Renaissance fund invests. Elmslie and Langley say they are satisfied that those companies have access to capital “when and as needed.” The companies will probably have to pay higher interest for borrowed funds, but they can recover these costs by charging higher regulated or long-term contract rates.

Of the infrastructure funds available in Canada, all but one — Investors Global Infrastructure Fund — are less than five years old and don’t have particularly meaningful performance records. The Investors fund, on the other hand, has an average annual compound return of 4.5% for the five years ended Oct. 31. That compares favourably to the average annual loss of 0.9% for global equity mutual funds for the five-year period.

Although infrastructure is a relatively safe investment haven, it is not immune to general drops in equities. The Investors fund was down by 23.8% for the year ended Oct. 31. However, it posted a gain of 27.6% in 2006, 7.8% in 2005 and 11.4% in 2004. And those were periods in which the Canadian dollar was climbing, which eroded returns on foreign equities when translated into C$.

In general, infrastructure funds invest in companies that own and operate infrastructure assets. These companies fall into two main business segments. The first is transportation (railways, toll roads and ports, for example), for which returns are affected by the level of economic activity — that is, they are tied to growth in gross domestic product.

The second segment includes those regulated industries that are not affected by GDP growth — energy (electricity generation and transmission, gas distribution, and oil and gas pipelines), communications (satellites, cellular towers and cable) and water utilities.

Companies are sometimes difficult to categorize, says Craig Noble, portfolio manager with Chicago-based Brookfield Redding LLC, because they are active in several sectors. Brookfield Redding, which is owned by Toronto-based Brookfield Asset Management Inc., manages the $5.1-million Brookfield Redding Global Infrastructure Fund, sponsored by Burlington, Ont.-based AIC Ltd.

Some fund managers also invest in sectors whose activities involve infrastructure. Fee, for example, invests in construction and engineering companies.

The Dow Jones Brookfield global infrastructure index, launched earlier this year, includes infrastructure companies from various sectors. The index is composed of 50% energy companies, 20% transportation, 13% communications, 10% water and 7% other companies.

@page_break@In times of economic weakness, managers of infrastructure funds can tilt their portfolios toward stable, regulated sectors. In fact, this is happening now, with most managers overweighting the energy, communications and water sectors because of the safety and stable income flows of companies in these lines of business.

“Once we have a strong recovery period,” says Noble, “we will overweight transportation.” In such a period, these companies should outperform because transportation volume will grow.

Longer-term prospects for investing in the sector are positive, particularly as governments are not going to be able to foot as much of the bill, says Fee. Historically, governments have provided 70% of the financing for infrastructure projects, but that is “definitely changing,” Fee says, suggesting there will be greater institutional and private investment in these projects.

There are a number of solid investment prospects in the sector. Existing global infrastructure companies are involved in the industry and should be able to find new projects continuously. And Fee doesn’t anticipate a flood of new companies entering the field: “There are high barriers to entry because of the capital required and the long-term nature of the assets.”

Here’s a look at some of the companies favoured by fund managers:



Energy

> Enbridge Inc. of Calgary, which is involved in gas distribution and oil and gas transportation via pipelines is popular with Brookfield Redding’s Noble, as well as with Elmslie and Langley of RARE. The latter have recently increased their fund’s holding in Enbridge.

The firm’s revenue is stable, thanks to a mix of regulated and long-term contractual business that is on a “pay or take” basis, which means shippers pay for shipping space whether they use it or not. As a result, say Elmslie and Langley, “Less than 5% of earnings are affected by commodity, volume or currency risk.”

“The company has a very strong management team,” adds Noble, as well as oilsands projects that will be accretive even with oil at US$60 a barrel.

> Fortis Inc. of St. John’s is the other Canadian company that fund managers mention. A gas and electric utility, Fortis serves more than two million customers. Its regulated assets comprise 90% of total assets and it’s very well diversified across Canada, says Mackenzie’s Bastasic. Fortis has a relatively high dividend yield, he notes, and has had strong double-digit dividend growth over the past five years.

> ITC Holdings Corp. , based in Detroit, is a pure electricity transmission play, say Elmslie and Langley. ITC is regulated under the favourable federal system rather than by states and has a return on equity of more than 13%.

> Red Electra De Espana Sau, a Madrid-based company, is the owner/operator of Spain’s electricity grid. Noble likes the company because electricity demand varies only slightly with fluctuating GDP.

Red Electra also provides consulting and advisory services, and invests internationally, primarily in Peru and Bolivia.

> United Grid PLC. Emslie and Langley, as well as Fee, note that this London-based company has a monopoly on gas and electricity distribution in Britain and is the predominant electricity transmission operator in the northeastern U.S. Its revenue is divided roughly 50/50 between the two regions.



Transportation

> Cintra Sa Concesiones De Intraestructuras De Transporte, based in Madrid, is the second most profitable toll-road operator in the world, says Bastasic.

In operation for more than 30 years, CCIT is an owner-operator with 18 roads in operation and five more under development. Contracts range from 30 to 100 years. The U.S., including the Skyway toll road connecting Chicago to the rest of Illinois, accounts for about 50% of CCIT’s operating profit. CCIT also co-manages Highway 407, which runs through the north end of Toronto.

“It has probably the best terms of any operator,” say Elmslie and Langley, “in terms of length of contracts and inflation factors.”

Governments, they note, tend to award contracts based on the operators’ track records.

Bastasic considers CCIT a core holding and notes that usage and rates on CCIT-managed toll roads have been increasing. “Toll roads,” he adds, “are expected to be a growing part of total infrastructure spending.”

> Vinci SA, based in Paris, both builds and operates toll roads, a dual role that Fee says is a plus.



Communications

> American Tower Corp. of Boston is one of three firms based in the U.S. that own cellular towers — essentially a real estate business, in that the firm rents the space on its towers to others to hold their equipment, says Noble. Prospects for American Tower are positive because there’s lots of space on the company’s towers for more tenants.

> France Telecom SA is dominant in France but also has a significant presence in Britain, Poland and Spain. In addition to land lines, FT offers mobile and television services.

Fee likes FT for its land-line network, which she prefers in this economic environment because of its stable revenue. IE