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Monday, September 26, 2022

Where could the infrastructure bill lead to high returns?

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As the house sets a path to pass the $3.5 trillion budget bill, you may be wondering who could see the benefit from this and where government investments could be made.

The bill will be the largest federal investment in the public system in over a decade, this would fund a wide range of areas including transportation, renewable energy, clean water, smart-grid electrical networks, and broadband internet. But the stocks that have grown are mostly companies that will see an immediate impact from infrastructure spending: Investors are missing the steak.

Infrastructure stocks have dipped a bit since the bill passed the Senate on Aug. 10, and this provides a little extra incentive for investors: These stocks have room to run as these programs materialize and projects are put into place over the next few years.

There are a dozen exchange-traded funds that focus solely on infrastructure stocks, and they take very different approaches. That can lead to strikingly different portfolios in terms of what they own, their average valuation, and which are best right now.

The $4.4 billion Global X US Infrastructure Development ETF (ticker: PAVE), for example, is over 70% of industrial stocks, which includes machinery and construction firms. 21% of it is in materials outfits such as steel and concrete producers. The $682 million iShares U.S. Infrastructure ETF (IFRA), meanwhile, has about half in those kinds of cyclical companies, and nearly 43% in utility companies like electric, gas, and water suppliers. The two funds, despite their similar names, have just 24% of their portfolios in common.

An analyst of Global X, Andrew Little says the firm’s infrastructure ETF doesn’t include utility firms since they’re usually the spender of federal funding, whereas industrial and materials companies actually receive the money and provide inputs to maintain or rebuild the operations. These companies have jumped in the past year—such as steel producer Nucor (NUE), up 165%, and machinery manufacturer Deere & Co. (DE), up 95%—but could continue their trajectory as economic activity picks up.

In contrast, the iShares ETF aims to capture the entire value chain of infrastructure development, including owners of the physical assets. These companies, such as Middlesex Water (MSEX), which owns water facilities, and NRG Energy (NRG), which owns nuclear-power plants, have seen gains this year, but not as much as cyclicals like industrials and materials, which make up about half the fund. The cyclical half trades at 44 times earnings—about 30% higher than their three-year average; the asset owners are priced at just 24 times, slightly below the historical level. Year to date, the Global X ETF has gained 27%, while the iShares ETF is up 21%.

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The $1.2 trillion infrastructure bill, if passed, will benefit these funds that invest in related companies.

ETF / TickerExpense RatioAUM (mil)YTD ReturnOne-Year ReturnPortfolio Makeup
Global X U.S. Infrastructure Development / PAVE0.47%$4,35626.8%57.4%Cyclical-focused (70% industrials, 20% materials)
iShares U.S. Infrastructure / IFRA0.4068220.743.9Half cyclical, half defensive (43% utilities)
ProShares DJ Brookfield Global Infrastructure / TOLZ0.4712715.818.0Defensive-focused (36% utilities, 29% energy, 18% real estate)
Invesco Water Resources / PHO0.601,91323.242.3Companies with products that conserve and purify water for homes, businesses and industries
First Trust Nasdaq Clean Edge Smart Grid Infrastructure Index / GRID0.7048620.754.3Companies involved in electric grid, energy storage, and enabling softwares, etc.
SPDR S&P Kensho Intelligent Structures / SIMS0.45517.636.3Companies driving innovation behind intelligent infrastructure

Note: Data as of Aug. 18, 2021

Source: Morningstar

“The market may not be pricing in the big benefits of the infrastructure spending on asset owners yet,” says Jeff Spiegel, head of iShares’ megatrend, sector, and international ETFs. Still, he says that the huge federal investment will eventually help these firms reduce expenses, adopt new technologies, and expand through acquisitions. That might be where the next leg of infrastructure-triggered growth comes from, he says.

There is another significant difference: The Global X ETF is weighted by its holdings’ market value; the iShares ETF is equal-weighted. That means the former tends to ride the momentum of larger stocks that have done well, while the latter tilts toward smaller names and scales back from winners every quarter. The average market cap of the two funds’ holdings are $16 billion and $6 billion, respectively.

The $127 million ProShares DJ Brookfield Global Infrastructure (TOLZ) is even more defensive: It invests only in companies that own and operate infrastructure—utilities and natural-gas pipeline operators, including Enbridge (ENB) and TC Energy (TRP), as well as real estate owners of cell towers, such as American Tower (AMT) and Crown Castle (CCI).

The ProShares ETF, which has very little overlap with the infrastructure ETFs from Global X and iShares, has returned 16% YTD. “These names don’t get quite the kick the cyclicals do, but in the long term, they get to add capacity and continue to make money with that added capacity,” says Scott Helfstein, ProShares’ executive director of thematic investing.

Half the fund’s assets are in foreign stocks: “The U.S. isn’t the only one investing in infrastructure,” says Helfstein. India just promised to spend $1.3 trillion on infrastructure, and China has been consistently investing in infrastructure even before the pandemic, especially in areas like green energy and digital networks.

For now, the businesses engaged in innovative technologies for cleaner, smarter and overall better connected infrastructure, will ultimately benefit from the government’s ambitious plan. Many of these companies are owned by ETFs such as SDPR S&P Kensho Intelligence Structures(SIMS), First Trust Nasdaq Clean Edge Smart Grid Infrastructure (GRID), and Invesco Water Resources (PHO). These ETFs are typically internationally focused and often trade at higher valuations compared to US infrastructure ETFs. They may not see an instant revenue boost, but infrastructure is all about the long-term.

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