How you can invest in an asset everyone is talking about — infrastructure
u0026nbsp;rnrnScan the headlines of any major news organization on any given day and there will be u003ca href=u0022https://financialpost.com/tag/infrastructure/u0022u003estories on infrastructureu003c/au003e: How to fix our crumbling infrastructure. How to build the necessary infrastructure to create future-friendly cities. How the definition of infrastructure is changing in a digital economy. And, of course, how every institutional investor is allocating enormous sums of capital to “infrastructure investments” to generate cash flows and growth to keep up with inflation.rnrnIt is certainly true that all jurisdictions across the globe have an “infrastructure deficit,” whether they’re striving to maintain woefully inadequate facilities that have been undercapitalized for decades or to keep up with the fast pace of the modern world, but let’s focus on the investing side by answering three questions: What is infrastructure? What are the options for investors to allocate to infrastructure? And should ordinary investors follow the lead of institutional investors and invest the way they invest?rnu003ch3u003eWhat is infrastructure?u003c/h3u003ernThe historical understanding of what constitutes infrastructure was generally reserved for the physical structures required for societies to operate, such as bridges, roads, tunnels, hydroelectric dams, railways and airports.rnrnThese certainly still qualify, but the definition has been significantly expanded in recent years to include parts of the digital revolution, those can’t-live-without systems such as fibre optics, cellphone towers, data centres and even cloud services and cybersecurity operations.rnrnEffectively, a working definition of what constitutes infrastructure today boils down to anything that is required in modern society for the transfer or protection of people, goods or information.rnu003ch3u003eHow to invest in infrastructure?u003c/h3u003ernThe most obvious and most liquid approach to infrastructure investing is to buy shares of companies that build or operate infrastructure, either individually or as part of an aggregated exchange-traded fund or mutual fund.rnrnFor example, Canadians can directly invest in the shares of companies such as Brookfield Infrastructure Partners LP, Canadian National Railway Co., Enbridge Inc. and Stantec Inc., or in an array of passive and active ETFs that provide geographical diversification and exposure to hundreds of publicly traded companies across the infrastructure spectrum.rnrnSome institutional investors buy the stocks of companies they believe in as part of their allocation to different sectors, but they tend to invest in private funds that provide more specific exposures to subsectors and geographies in the infrastructure space.rnrnThe most obvious and most liquid approach to infrastructure investing is to buy shares of companies that build or operate infrastructure, either individually or as part of an aggregated exchange-traded fund or mutual fund.rnrnFor example, Canadians can directly invest in the shares of companies such as Brookfield Infrastructure Partners LP, Canadian National Railway Co., Enbridge Inc. and Stantec Inc., or in an array of passive and active ETFs that provide geographical diversification and exposure to hundreds of publicly traded companies across the infrastructure spectrum.rnrnSome institutional investors buy the stocks of companies they believe in as part of their allocation to different sectors, but they tend to invest in private funds that provide more specific exposures to subsectors and geographies in the infrastructure space.rnu003ch3u003eShould I invest the way institutions do?u003c/h3u003ernAs with all good questions, the answer to this question is that it depends. On the publicly traded side of things, individuals can certainly benefit from the growth and liquidity enjoyed by institutional investors in the same space.rnrnOn the private funds side of things, there are a number of reasons that individuals (meaning high-net-worth individuals who are able to access private investments) might invest in infrastructure somewhat differently than their institutional counterparts. The three main differences between institutional and individual investors are their tax status, their required rate of return and their investment horizons.rnrnMost institutional investors are tax-exempt, meaning that their before- and after-tax returns are the same. Individuals enjoy a lifetime partnership with the Canada Revenue Agency, so any taxable cash flows or growth earned through their investments are highly taxed, often leaving less than half of what they started with.rnrnIn addition (and perhaps in part as a consequence of their tax-exempt status), most institutional investors may require lower returns from the investments they make than individuals, meaning that a six per cent to eight per cent total return, even in a higher interest rate environment, can be acceptable, whereas those returns might not work for highly taxed individuals.rnrnInstitutions also tend to have 50-plus-year investment horizons. Although they must ensure that their stakeholders (such as pensioners) receive the money they are due in real time, they must equally ensure that they will be solvent generations into the future in order to satisfy their obligations to the people they serve and represent.rnrnIndividuals (especially high-net-worth individuals) also purport to have intergenerational investment time horizons, but are far more likely to fall into the “what have you done for me lately” category than their institutional counterparts.rnrnAs a result, individuals should probably not think of infrastructure investing as primarily a cash-flow vehicle (in which they might be disappointed with both the amounts received and the taxation applied to those cash flows), but rather as a growth vehicle that can provide significantly higher returns and are more tax efficient because those gains are typically taxed as deferred capital gains instead of ordinary income.rnrnThis approach requires these investors to look not at the core infrastructure funds described above, but at diversified, long-term, “value-add” funds that build and stabilize the assets that will generally end up in the core funds that generate the cash flows that institutions seek.rnrnAlthough these funds can produce materially higher returns than the core funds, they do carry the operational and financial risks associated with the development of any infrastructure assets, and since the projects don’t produce cash flows until they are built and stabilized, many of these funds don’t offer real-time distributions to investors.rnrnIn sum, the long-term, risk-adjusted performance of value-add infrastructure funds (especially on an after-tax basis) can be very attractive, similar to those found in other long-term investments in real estate development and private equity.
