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The case for infrastructure: selling shovels to improve your investments

Ursula Tonkin  |  17 Mar 2020Text size  Decrease  Increase  |  
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They say that in a goldrush it is not the miners who make the money but the people who sell the shovels. The reason is simple: while miners may or may not strike luck in their search for gold, the people who sell the shovels will make a profit no matter what.

The same is true for the economy overall; core infrastructure like roads, electricity and water is required for a business to function. The business may or may not be profitable, but the companies providing the vital infrastructure will make money from providing these services anyway.

Yet, until a decade ago or so, infrastructure investments never featured prominently in investor portfolios only as small allocations to utility companies. To continue to educate investors on the benefit of investing in infrastructure investments, we will look at what happens to an investor’s return profile if we replace a 100 per cent allocation to global stocks in a portfolio with a 75 per cent allocation to global stocks and a 25 per cent allocation to global core infrastructure stocks.

We have tracked such a portfolio since 2006 through the ups and downs of the global financial crisis and the decade since. We started in 2006 for no other reason than this is when we started to have reliable performance data for infrastructure stocks in the form of the FTSE Developed Core Infrastructure index.

This index tracks core infrastructure companies (i.e. companies that operate in regulated markets with stable cash flows and profit margins) in developed economies around the world. Figure 1 shows how the risk and the return of the portfolio would have changed.

Figure 1: Risk and return of portfolios with and without infrastructure stocks

Risk and return of portfolios w and without infra stocks

Source: Bloomberg, Whitehelm Capital. Past Performance is not a reliable indicator of future results. As at 31 July 2019.

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From the above, we can see how introducing a core infrastructure allocation would have increased an investor’s return and lowered the risk over time. The average annual return of the portfolio with infrastructure stocks is 1.2 per cent per year higher than without infrastructure stocks. That may not sound like much, but it does accumulate over time as Figure 2 shows. For every $1000 invested in the portfolio since 2006, the investor would have earned an additional $360.

Figure 2: Performance of portfolios with and without infrastructure stocks


Source: Bloomberg, Whitehelm Capital.  Past Performance is not a reliable indicator of future results. As at 31 July 2019.

Infrastructure stocks, especially when they operate in regulated markets with natural monopolies, tend to be rather boring. They are mostly chugging along nicely, making money whether the economy is doing well or not. That is the benefit of providing a service that everybody needs all the time: you keep making money all the time.

It is this low volatility returns profile of infrastructure stocks which helps portfolios perform better because in times of crisis, these stocks lose less than the overall stock market. Take for instance the global financial crisis of 2007 to 2009. It was the most extreme crisis for the global economy in seven decades and put every portfolio to the test. From November 2007 to February 2009, the global stocks lost about 42 per cent in value.

In comparison, the simulated portfolio with 25 per cent infrastructure stocks dropped only 36 per cent because infrastructure stocks dropped “only” 13 per cent in that time frame.

Figure 3: Drawdowns of portfolios with and without infrastructure stocks


Source: Bloomberg, Whitehelm Capital.  Past Performance is not a reliable indicator of future results. As at 31 July 2019.

But losses are losses, so why make such a fuss about 6 per cent more or less drawdown in a crisis? The reason is the less your portfolio declines in bad times, the quicker it will recover from its losses and the more time it has the potential to increase your wealth. If we look at the development of the portfolios with and without infrastructure stocks after the massive decline in 2007 and 2008 this becomes clear.

The portfolio with infrastructure stocks dropped 36 per cent until February 2009 and then took until November 2013 to recover these losses. In contrast with this, the global stock portfolio was still under water for another year until November 2014!

Counting your money, not climbing out of a hole

Infrastructure stocks are a valuable addition to investor portfolios and deserve to receive their dedicated allocation. This is not because infrastructure stocks are high growth investments that promise superior returns to the overall stock market.

Instead, investors should expect similar returns to the overall stock market but crucially, lower risks in difficult economic times. Infrastructure companies tend to make money even when more cyclical businesses do not simply because they provide services that are always required.

The defensive nature of their earnings means infrastructure stocks provide a level of downside protection. This helps investors to climb out of the hole more quickly after an economic contraction or a stock market decline.

In other words, when the miners were still climbing out of their holes, the people who sold the shovels were already counting their money.

Consequently, there is an argument to be made that “selling shovels” by investing in infrastructure stocks makes for higher quality investment portfolios.

head of listed strategies at Whitehelm Capital

This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. 

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