The Movement to Rebuild America’s Infrastructure
On March 8th, 2017, we launched the Global X U.S. Infrastructure Development ETF (PAVE), which invests in companies that potentially stand to benefit from an increase in infrastructure projects in the United States. Such an increase could be driven by the introduction of fiscal spending bills or tax incentives to stimulate the undertaking of new projects, increases in private investment given additional profitable opportunities, or streamlined regulations that fast-track the approval process for infrastructure projects.
Unlike many existing infrastructure funds, which tend to primarily invest in Utilities and Energy companies, PAVE invests in; 1) companies involved in the construction and engineering of infrastructure projects; 2) the production of raw materials, composites and products used in building infrastructure projects; 3) producers and distributors of heavy construction equipment; and 4) companies engaged in the transportation of materials use in infrastructure projects.
In this piece, we will answer four key questions:
- How important is infrastructure to economic growth?
- What is the current state of the US’s infrastructure?
- What are some potential approaches to stimulate infrastructure development?
- How does PAVE approach infrastructure investing?
How Important Is Infrastructure to Economic Growth?
Infrastructure includes highways, streets, rail, transit, airports, seaports, waterways, waste management, power grids, communications equipment, and pipelines. Infrastructure is the backbone to any economy as it facilitates the movement of goods and labor, which allows for greater competition, higher productivity, and reduced costs. Therefore, many economists believe that increases in public or private spending on infrastructure development can significantly boost economic growth. According to research from S&P, a 1% increase in US infrastructure spending as a percentage of GDP translates to a 1.7% increase in GDP over the next three years, or a 70% return on investment.1
What Is the Current State of the US’s Infrastructure?
The US’s infrastructure, which was largely built in the post-WWII period of the 20th century, is rapidly aging, while suffering from a shortage of funding required to maintain these assets. While spending on infrastructure construction has nominally increased at an annualized rate of 3.6% over the last 15 years, it has actually decreased at an annualized rate of -0.2% once controlling for inflation and real GDP growth. These numbers tell an even more troubling story when broken into various segments of infrastructure. In the chart below, note that the Power segment, which includes electric power generation & distribution and the storage and transportation of oil and natural gas, is the only category demonstrating real construction spending growth relative to GDP.
As a result of this low level of investment in infrastructure maintenance and development, the US’s infrastructure assets are deteriorating and in dire need of repair: The American Society of Civil Engineers (ASCE) gave America’s infrastructure a D+ on its quadrennial ‘Report Card’, noting that neglecting infrastructure can have severe negative economic consequences for the country. ASCE believes that a failure to address the nation’s infrastructure needs could result in a loss of $4 trillion of GDP and 2.5 million jobs by 2025.2
The amount of investment needed to rebuild and expand the nation’s infrastructure is huge. ASCE believes that the country will need to spend $3.3 trillion on infrastructure from 2016 to 2025, and nearly $10.8 trillion by 2040.3 Yet nearly half of these requirements are currently unfunded, necessitating significant increases in investments from public and private sources.
What Are Some Potential Approaches to Stimulate Infrastructure Development?
There are several potential methods to stimulate increased infrastructure development. A few examples are:
At local levels:
- State and local governments can use public funds to develop new infrastructure projects, primarily through the issuance of tax-advantaged muni bonds.
- They can also turn to public-private partnerships, which allow for private companies to bid for public infrastructure projects while local governments or tolls subsidize the private firm.
- Municipalities could leverage tax increment financing (TIF), which allows localities to fund infrastructure development projects with future increases in property tax revenues.
At a federal level:
- The US government could pass additional infrastructure spending bills, like the 2015 “Fixing America’s Surface Transportation Act” (FAST Act), which allocated $305 billion over 5 years to fix America’s aging highways, rail, and public transit.4
- Another method, which is favored by the Trump administration, is for Congress to pass tax incentives for infrastructure spending which could potentially improve the economics for privately funded infrastructure projects, such as toll roads.
- A non-monetary stimulus to infrastructure development would be a streamlining of federal regulatory hurdles facing large-scale infrastructure projects, which could potentially reduce costs and accelerate their development.
How does PAVE Approach Infrastructure Investing?
Many approaches to investing in infrastructure tend to focus on the owners and operators of existing infrastructure assets, rather than on the companies that derive a significant portion of their revenues for building or maintaining infrastructure assets.
For example, over 90% of the US components of S&P Global Infrastructure Index are utilities and energy companies that operate infrastructure assets.5 While these companies do make investments to maintain and develop infrastructure, they potentially stand to benefit from only a minor portion of total infrastructure spending in the US. In 2016, these firms were responsible for one-third of total infrastructure spending in the US.6 In addition, 40% of these firms’ infrastructure spending was not an investment in new infrastructure, but an expense to maintain existing assets. Therefore no additional cash flows are expected to be derived from that portion of their infrastructure spending. When considering the portion of funds that are channeled towards building new infrastructure assets, additional revenue from these projects could still take years to materialize.
Given the concentration of publicly traded infrastructure companies in the Utilities and Energy sectors, much of their investment is concentrated in only a few segments of infrastructure. Therefore, companies in these sectors do not participate in a significant portion of infrastructure development, such as building roads, bridges, and water infrastructure.
Instead of focusing on companies that operate existing infrastructure assets, PAVE is designed to provide exposure to companies that can derive additional revenues from increased spending on both publicly and privately funded infrastructure projects, stand to earn these additional revenues regardless of whether the project is maintenance of existing assets or developing new infrastructure, and can collect these revenues years before the projects are completed. These companies include those involved in the construction and engineering of infrastructure projects, the production of raw materials, composites and products used in building infrastructure projects, producers and distributors of heavy construction equipment, and companies engaged in the transportation of materials used in infrastructure projects.