Select emerging market (EM) companies are an increasingly attractive part of the global listed infrastructure universe. When added to a portfolio of developed market stocks, EM securities offer a greater source of income and differentiation in returns.
Companies with long track records of stable, growing earnings can suit the defensive investor seeking income from their assets. If the end investor also seeks lower volatility for their investments, regulated infrastructure companies in developed markets, with tried and tested regulation, may suit even better.
Proven regulation is more commonly found in developed markets for infrastructure stocks such as water, gas and electricity companies. As such, creating a portfolio of developed market infrastructure companies chosen for their likelihood of offering sustainable growth in income and capital is logical.
And yet, emerging markets (EM) by their very nature are changing rapidly and to exclude stocks from such countries can limit diversification opportunities. Countries such as Brazil have robust regulatory frameworks for utility companies that are comparable to developed countries. Yields can be higher for EM utilities too, as their revenue is often indexed to local inflation and base rates.
So, by widening the opportunity set to include EM listed infrastructure within agreed limits, investors can broaden the growth and yield profile of their investment, as well as diversify their regional exposure.
Total Return Decomposition - EM utilities vs Developed Market (DM) utilities
Measured over 10 years, 1 February 2008- 31 January 2018
A building boom in EM infrastructure
EM infrastructure looks to have a long market cycle ahead of it, as expanding economies put in place plans to create greater supplies of water, energy, roads and communications. This is being driven by urbanisation and much higher rates of growth than developed markets; the International Monetary Fund forecasts the gross domestic product of emerging market countries to rise from 4.7% in 2017 to 5% in 2019. By contrast, developing countries are expected to grow by 2.2% in 2019, a fall from 2.3% in 2017¹.
This growth is expected to push the total value of EM infrastructure higher than developed-markets infrastructure assets by 2030, according to research by David Hale Global Economics². This is predicted to take the value of public and privately-owned infrastructure assets worldwide from US $22 trillion in 2014 to US $60 trillion in 2030, while by contrast developed markets assets will only rise from $27 trillion to $50 trillion. This illustrates how widely the EM infrastructure opportunity set is likely to grow.
Investors in emerging markets will be open to currency fluctuations in the value of their investments. In addition, investors need to be aware of higher volatility in emerging markets compared to developed markets. The standard deviation of the MSCI Emerging Markets Index (USD) is 22.6% over 10 years to 31/01/18, while for the MSCI World it is 16.2%. However, some investors are willing to take on the risk necessary to receive the potential rewards on offer in these markets.
When blended into a portfolio of global listed infrastructure stocks, carefully selected emerging market stocks can offer a greater source of income, returns and diversification. They also help diversify risk and widen the opportunity set giving the potential for greater risk-adjusted returns.
¹ World Economic Outlook Update, January 2018, International Monetary Fund https://www.imf.org/en/Publications/WEO/Issues/2018/01/11/world-economic-outlook-update-january-2018
² David Hale Global Economics 2014