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Is Listed Infrastructure The Most Attractive Investment Avenue Now?

Summary In the current global scenario where traditional asset classes no longer assure stable returns, listed infrastructure is attracting investors in a big way. In 2015, investors have largely been cautious about the equity markets due to expectations of stable growth in the US and the likely interest rate hike by the Fed. However, inconsistent economic indicators, the Greek crisis, and a slowdown in China impacted returns. Even amid concerns about the global economy, bond yields were at their lowest in most developed economies, making fixed income investments unattractive. Global fund managers consider real estate an alternative investment avenue for stable returns on their investments, as real estate assets are likely to witness substantial price appreciation. By Ati Ranjan and Subarna Poddar Global fund managers consider real estate an alternative investment avenue for stable returns on their investments, as real estate assets are likely to witness substantial price appreciation. Listed infrastructure, an up-and-coming segment of the real estate sector, is gradually gaining traction among fund managers due to its monopolistic nature, price inelasticity, stable predicted cash flows, and inflation hedging characteristic. Although these assets are also traded in the form of equities, the underlying asset is immune to default risks due to strong government backing. Furthermore, these equities act as defensive plays during the downturn. Listed infrastructure assets are largely government or quasi-government owned. The sovereign backing makes ongoing infrastructure projects less likely to default compared with other privately held real estate asset classes. These assets work in a cost plus model; hence, profitability is already hedged. Also, listed infrastructure assets typically enjoy monopoly due to entry barriers set by the local governments, thus maintaining stable cash flows. Demand for these assets is often inelastic to price changes, such as electricity, water, toll, as people continue using these utilities despite tariff changes. Thus, this asset class provides stable returns even during an economic downturn. Although investment in infrastructure is capital intensive, the equity route makes it cheaper, investor friendly and keeps transactions transparent. High-return, moderate-risk asset class What is listed infrastructure? Listed infrastructure is a comprehensive and diversified asset class of largely state-owned or public-private partnership (NYSE: PPP ) companies that develop, manage, and own assets related to energy, communications, water, transportation, and other systems essential for an economy. This asset class is segmented into small units and listed as equities on stock exchanges. Hence, the quantum of investment is lower than that of a direct investment in real estate. Furthermore, these equities act as defensive plays and protect investors during market corrections as they carry low default risk and are backed by sovereigns. The asset class outperformed during pre and post crisis period If we compare the performance of the S&P Global Infrastructure Index with its peers over the pre and post economic crisis period, we can see that infrastructure clearly outperformed during the pre-crisis (2006-07) and post recovery period, i.e., 2012 onward. During the recovery period (2010-2011), the asset class clearly outperformed equities (S&P 500 Index). The chart below shows that the asset class has remained superior to equity investments over 12 years and, hence, we can conclude that it offers better returns irrespective of the economic conditions. Performances of various asset classes over last 12 years: Source: Bloomberg Most attractive features of listed infrastructure Financial and operational performance · Access: Direct exposure to global basic infrastructure facilities that are monopolistic · Liquidity: Liquid exposure to infrastructure investments, and no issue with deal flows and fixed investment horizon · Transparency: Access to existing and established infrastructure facilities, and no issue with blind pool investing · Low impact of regulatory changes: Regulatory changes are managed by governments; as these assets are primarily government or PPP projects, the regulatory changes are likely to have low impact on them · Diversification: Allows global investors to easily diversify their portfolio holdings as per the specific risk profile (e.g., geographic allocation, currency, level of gearing, and regulatory and political risks) · Cost: Cost is lower than unlisted infrastructure investments or direct buying/selling of properties · Level of gearing: Lower level of gearing than unlisted infrastructure and real estate firms, and primarily backed by government funding Classification of listed infrastructure Source: Aranca Research Cash generation and return · Higher dividend: Dividend accounted for over 33% of the overall returns of the S&P Global Infrastructure Index in the last 10 years; average dividend growth outpaced average inflation. · Predictable cash flow: The assets work in a cost plus model; therefore, future profitability is secured. · Inflation protection: Revenues of listed infrastructure companies are linked to inflation, thereby providing protection against it. (i.e. concessions permitting rent escalations linked to inflation, regulated price mechanisms that consider rate of inflation) Growth in dividend per share of listed infrastructure companies vs. CPI (click to enlarge) Source: Bureau of Labor Statistics, IMF, Bloomberg, Aranca Research Operational risks Delays: Since these kinds of projects are majorly government owned, there are possibilities of delays in project execution; this could interrupt income generation from the project. Financing: As many emerging market economies are facing funding shortage, there is possibility of slower disbursement of resources as well, as big funding organizations may not sanction adequate grants. Recovery of other alternative asset classes: Other asset classes could recover at a faster pace and make investment in listed infrastructure assets less attractive. Why listed infrastructure? Since the beginning of 2015, global equity markets have witnessed significant volatility due to a series of global events. Slowdown in China’s economy, declining GDP of Japan and the Greek debt crisis dampened investor sentiment. The Eurozone still has a long road ahead in terms of complete recovery. Amid a strengthening dollar, emerging economies such as China and India are not offering encouraging signs to equity investors. The US is the only market that has performed fairly well in 2015 compared with other geographies, supported by a bullish dollar and an expected rate hike by the US Federal Reserve later this year. The ongoing volatility in oil prices have kept investors directionless. Oil prices witnessed a steep fall until mid-2015, primarily due to strong non-OPEC oil production forecast. The OPEC’s refusal to reduce oil output worsened the situation. Furthermore, the withdrawal of sanctions on Iran after the nuclear deal exerted pressure on oil prices. The weak outlook for oil prices impacted the earnings of companies in the energy sector across the world, which consequently reflected in their stock prices. In addition, the ongoing drop in commodity prices affected investor sentiment across global markets. Separately, possibility of new drug pricing rules triggered negativity about biotech stocks, which was once considered the most defensive sector. Performance of major global equity indices (2015 YTD) Source: Bloomberg Among the investment options available, portfolio managers prefer fixed income or bonds, real estate investment trusts (REITs), bullion, and listed infrastructure to create a balanced portfolio. Bond yields globally are already under pressure and reached their all-time lows in January 2015 (US 30-year Treasury yield at +1.7%, UK 10-year gilt yield +1.4%). Moreover, any increase in the rates, especially a rate hike by the US Fed, would make them an unattractive investment option. With regards to gold, a sharp drop in its prices has severely impacted its safe-haven status. With continued decline in commodity and gold prices, the bullion price is expected to remain under pressure in the near term. Real estate is another alternative that provides higher capital gains; however, it is capital intensive and, hence, represents higher risk. In such a scenario, where most of the sectors are underperforming, a defensive play with stable returns and moderate risks is likely to gain attention of the global fund managers. Listed infrastructure is an asset class with all the above mentioned qualities. It offers high returns as well as steady income and assured capital benefits. The equity route makes it less capital intensive and provides benefits of the bull-run during positive economic scenario. Furthermore, this asset class is inflation protected. The inflation-linked nature of revenue from infrastructure businesses enables an automatic hedging against any rise in interest rates, thereby providing listed infrastructure an edge over other investment options. Market size of listed infrastructure assets to rapidly increase According to McKinsey Global Institute, infrastructure investment of around USD57 trillion would be required to achieve the projected global GDP by 2030, accounting for 3.5% of the expected global GDP in 2030. Furthermore, the Organization for Economic Co-operation and Development estimates a required global investment of USD40 trillion in new and existing infrastructure projects by 2030. With such large infrastructure spending, opportunities in listed infrastructure are expected to substantially increase. Market capitalization of listed infrastructure assets has increased to USD3.3 trillion in 2015 YTD as compared to USD861 billion in 15 years ago. Market capitalization of global listed infrastructure Source: Aranca Research The advancements in the global listed infrastructure market have enabled easier access to an asset class that has been traditionally illiquid. Historically, the global listed infrastructure market has performed robustly irrespective of the market scenario. This asset class offers higher returns at moderate risk. Currently, in addition to several smaller-sized funds, six major global funds are operating in this segment, with a combined asset size of USD4 billion. Some major players in the listed infrastructure segment that hold investments from top global fund managers are: Source: Fund fact sheets, Aranca Research Larger players attract major portion of investments in listed infrastructure The S&P Global Infrastructure Index comprises 76 companies, with a combined market capitalization of nearly USD1.2 trillion. The top 10 companies account for a large portion of the market capitalization. In terms of sector classification, Industrials accounts for 40.7% of the total index weight, followed by Utilities (39.3%) and Energy (20.0%). The key index players attract higher investments from global fund managers. S&P Global Infrastructure Index Country Number of constituents Index weight (%) US 22 35.1% Canada 7 7.9% Australia 4 7.8% Italy 4 7.1% UK 4 6.9% France 3 6.9% China 8 5.9% Spain 2 5.2% Japan 4 4.1% Germany 2 2.7% Singapore 3 2.6% Mexico 2 2.3% New Zealand 1 1.3% Switzerland 1 1.3% Brazil 3 1.1% Chile 2 0.7% Austria 1 0.4% Hong Kong 2 0.4% Netherlands 1 0.3% Source: Index fact sheet Listed infrastructure – an attractive alternative investment in current scenario Listed infrastructure assets have high potential for steady returns, low volatility, diversification, higher income, longer duration, and abundant capacity. Such investment options were traditionally considered off-market activities; however, listed infrastructure is an upcoming and promising real estate investment alternative, and is likely to be widely accepted globally. We believe the asset class is not overvalued and is trading at a fair projected 12-month P/E of 8.05x (P/E of S&P Global Infrastructure Index) compared with 15.2x P/E of S&P 500, offering significant opportunities for investors. Emerging investment opportunities in the water, communications and transmission, transportation, and distribution sectors are expected to substantially influence the listed infrastructure segment, driving growth in this segment and attracting long-term investors. Upgrading infrastructure is expected to become one of the key focus areas for governments of emerging economies. Demand for electricity, water, and sanitation would significantly increase due to higher population growth and urbanization. Hence, despite the recent drop in commodity prices, resource-rich governments would continue investing significant capital into infrastructure investments. Key drivers of listed infrastructure assets across the world are: Global population growth: According to the IMF projections, the global population is expected to grow over 8 billion by 2020. Increasing population requires additional housing and power supply, public transport, clean water, healthcare, and education facilities, which would further increase demand for public spending in the infrastructure sector. Increasing wealth: With per capital income growing in developing countries, the population would start expecting world-class infrastructure facilities. Economic expansion: Economic expansion in Brazil, Russia, India, and China (BRIC nations) and Southeast Asia would boost government spending on social infrastructure. Urbanization: With growing urbanization in the developed as well as developing countries, demand for road transportation, telecom, and energy utilities is expected to significantly rise. Climate change: Improved long-distance infrastructure is essential not only for more efficient provision of energy but also for potentially remote and renewable energy resources such as solar and wind. Climate change represents both a challenge and an opportunity for development in emerging markets. Limited supply: Roads, airports, and pipelines can only operate up to a fixed maximum capacity, beyond which additional assets are required. As emerging markets develop, governments typically focus on ensuring the transport infrastructure is sufficiently robust to support growth. Shift in financing: As governments worldwide increasingly face fiscal constraints, particularly in the developed world, the private sector is expected to be involved greatly in construction responsibilities through the PPP route. The private sector is actively involved through PPP into listed infrastructure projects in Australia, Europe, Canada, and the US, and this trend is expected to continue. Performance of two of the largest listed infrastructure funds Source: Fund fact sheets Major listed infrastructure funds and their asset size (click to enlarge) Source: Fund fact sheets, Aranca Research Breakdown of the listed infrastructure investment universe Source: Aranca Research.

Portfolio Development – My Approach

Summary Standard portfolio development theory provides a great foundation. Unfortunately, the stock and bond markets don’t always cooperate. Take the approach of accepting what the markets offer to improve total return. Introduction There are literally dozens of articles and books written on the subject of portfolio development theory. Most of those articles and books approach the development of a portfolio using a mix of stocks and bonds with the mix dependent on the investors tolerance for risk and the investor’s age. I think that this “standard” approach to portfolio development is great if you have the luxury of time to build that portfolio over a number of years and business cycles. Without the luxury of time, I don’t believe the “standard” approach works all that well. Making things even more difficult, today we have a unique investment environment. Yes, it really is different this time. We are currently in a period of ultra low interest rates with the most likely course going forward being slowly rising rates. Bonds may not return much over the next few years and if the economy and inflation accelerate, total return could be negative. What is an investor to do? My approach is to accept what the market has to offer. Standard Portfolio Development As stated in the introduction, there is a lot of information available on portfolio development theory. It is not my intent to provide a detailed discussion on the subject of standard portfolio development. I will summarize what I consider to be the standard approach in this section and refer the reader to articles available on the internet if more detail on the standard approach is desired. Most portfolio development starts with identifying the investor’s tolerance for risk. Because the risk of having poor or even negative returns can be mitigated with time invested, an investors risk tolerance also has an age component. Younger investors can generally tolerate more risk because they have many years to invest and accumulate wealth. To see the market behavior over various time periods, you could look at available charts . Another option is to use a market return calculator to look at various time periods. While you might be able to find a 30 year period with a slightly lower return if you work at it, the stock market has returned 8% – 9% average per year for any 30 year period since 1900. The bottom line is that time in the market lowers your risk of having a poor return provided you have a reasonably diversified portfolio of stocks. The standard portfolio model also uses diversification between asset classes to mitigate risk. Assets are typically divided primarily between stocks and bonds with a cash account outside the portfolio sufficient to cover 3 – 6 months of living expenses or for other emergencies. The rationale behind splitting the main portfolio between stocks and bonds is that the two asset classes typically complement each other. If equities have a terrible year, the investor should still receive a positive return from their bond holdings. One long standing rule of thumb for the split between stocks and bonds is to use 120 minus the investors age as the percentage for equities in the portfolio. As an investor ages, the portfolio percentage dedicated to stocks drops. The table below illustrates the portfolio stock percentage as a function of age. While this is a decent rule of thumb to follow, there is no universally agreed split between stocks and bonds and some recent thinking is that the typical split between stocks and bonds as a function of the age of the investor may need to weight more heavily stocks versus bonds. The reason for this shift to a relatively higher asset allocation to stocks is because we have had a long bull market in bonds and current yields are extraordinarily low. This makes it less likely that bonds will provide adequate returns going forward at least relative to historical returns. Stocks and bonds should also be diversified within the respective asset class. Depending on the value of the portfolio, it may not be practical for an individual investor to achieve the level of diversification necessary to adequately mitigate risk. Diversification in stocks is easier to achieve because stocks can typically be purchased in small increments. This is not the case with individual bonds. As an example, a round lot for a stock investment is 100 shares and the cost penalty for an odd lot (

Invest In The Philippines – Buy The IShares MSCI Philippines ETF

Summary High growth English speaking economy entering the demographic window and with great jobs growth. Very low household debt at 6% of GDP and a strong property market. The PSEi has moved sideways in 2015 providing a nice entry point now. The Philippines has been undergoing rapid change in the past decade and is set to continue as they enter the “demographic window.” It is one of very few countries in the world that speaks perfect English and still has cheap labor. But first some key reasons to invest in the Philippines stock market; GDP growth at 5.6% pa – the third fastest in Asia. Strong domestic driven economy not very affected by the China slowdown, with resilient overseas remittances. Rising middle class, and very strong demographics. The stock market has recently retreated and valuations are now better or fair. The Philippines GDP growth target set by the Government is for 7-8%pa growth. Other countries once they have entered the demographic window have posted an average growth of 7.3% during the first 10 years. According to the IMF the Philippines is currently growing at 6.0% in 2015, and forecast for 6.3% in 2016. The two main drivers of the Philippines economy are Overseas Foreign Workers (OFWs) remittances, and Business Process Outsourcing (BPO), which mostly covers call and data/back office processing centers. OFW remittances are growing around 6%pa , contributing $25b in 2014. The BPO sector is growing rapidly around 15%pa, contributing $18.9b in 2014, and employing over 1m people. It is expected that BPO revenues will overtake OFW remittances by around 2017 . Add to this a growing tourism and manufacturing sector (mostly electronics) and some agricultural exports and the economy is very resilient. With strong money inflows into the Philippines and rising jobs the property sector is also booming. There is a massive pent up demand for housing, and household debt is extremely low at a mere 6% to GDP. As a result the property developers (Ayala ( OTC:AYAAY ), Robinsons, SM) and the major banks (BPI, BDO, and Metrobank) are also booming. The banks are making good net interest margins around 3.02% , and growing their loan books 20% pa, with non-performing loans at a very low 1.8% and double digit profits. Total Philippines debt is relatively good. According to McKinsey research : The Philippines is one of the few countries in the world that has seen deleveraging. The ratio of total debt-to-GDP has been flat since 2008. In fact, it has declined if we look as far back as 2000. Corporates have the highest share of debt as a percentage of the economy at 71%, followed by the government at 40% and households at 6%. The current Government seems to have reduced corruption, and has brought the Government debt down and increased infrastructure spending. Source The Demographic Window In 2015, the median age in the Philippines is only 23.4 yo. The “demographic window”, is loosely defined as a period when a great majority of the population are of working age. The Philippines working-age population (between 15 and 64 years old) this year (2015) accounts for 66.6 percent of the total population of 101.6 million. By 2020 this will have reached 68% and by 2030 70.6%. Source Living here in metro Manila, I can certainly testify that the growth is real. Everyday I see Filipinos rising into new employment (maybe a call centre, or property agent), buying a smartphone, and buying condos. Jobs ads are often for 500 workers at a time. Manila skyline is changing rapidly under a construction boom. New cities within Manila have been growing and continue to be planned such as the Mall of Asia Entertainment (Casino) City , the Las Vegas of Philippines. Currently being built it will provide 4 new casinos, 6,000 hotel rooms, and 1.8m new jobs for the whole of Entertainment City. Global City (within Manila) is a whole new international business district that has grown from nothing in a mere decade. Global City Skyline Source The Philippines Stock Exchange (PSE) Index (PSEi) The best way, in my opinion, to invest in the Philippines stock market is to buy the index. The PSEi is currently at 6,932 down 2.93% for the past year, and the index has a year low of 6,603 and a high of 8,136 (see graph below). (click to enlarge) Source The PSEi trades on a current PE of 19.88. iShares MSCI Philippines My recommendation for Americans and most international investors would be to simply buy the index using the iShares MSCI Philippines ETF (NYSEARCA: EPHE ). The index is well diversified with the largest sectors being property developers and banks. The top 5 holdings are Ayala Land, Philippines Long Distance Telecommunications (NYSE: PHI ), Universal Robina Corp. ( OTCPK:UVRBY ), JG Summit ( OTCPK:JGSMY ), and SM Prime ( OTC:SPHXY ). If you want exposure to one of the fastest growing economies in Asia and the World, with brilliant demographics and a rising middle class, with strong jobs growth, at a reasonable valuation then EPHE is a great long term investment. Risks The usual risks apply to emerging markets. Currency risk would be the main one to consider. Also there will be an election in 2016 and a new Government. Geo-political risk is another with recent South China Sea issues with China.