Infrastructure Investing

Here at Fundgurus we've discussed various investment themes and this latest article looks at Infrastructure as an investment theme.

'Infrastructure' is a broad term and I generally think of it encompassing areas such as utilities, transport (airports, railways, roads) and schools and hospitals. Infrastructure investment is something that is always required, whether it be to initially install the facility, or to improve or update existing infrastructure.

Often infrastructure is heavily supported by public spending and government policy. By investing in high-speed railways for example, governments can make their country more attractive to businesses and investment which helps support the economy. At the same time it creates jobs in the immediate term to actually build the infrastructure. With governments looking to stimulate economies there is a possibility we will see them target infrastructure directly, and we have actually seen the beginnings of this with Japan and U.S. policy.

Infrastructure can also provide an inflation-hedge. Real assets such as buildings have exhibited inflation protection in the past. Revenues, such as those from toll roads, are often linked to RPI and therefore also offer inflation protection.

For investors there are various funds and stocks available to invest in this infrastructure theme. HICL Infrastructure is a closed ended investment trusts (HICL) and has an attractive yield (c. 5.7%). First State Global Listed Infrastructure is an open ended fund investing in companies that are linked to the inflation theme. This provides a more global portfolio, but has tended to exhibit slightly more volatility then HICL.

This type of investment can produce steady returns making an attractive addition for portfolios for the long term investor.

Rising Costs and Wage Inflation

Rising costs globally have had detrimental effects on company profits and a fundamental cause of this has been wage inflation particularly in emerging markets.

As Asia contributes to a large proportion of global manufacturing, company profits are being squeezed as it becomes more costly to produce in these countries.  Costs have been further amplified by the rising currencies.  Emerging markets have seen their currencies rise as investors seek to capitalise on high GDP growth.

Asia has seen soaring wages and average pay has almost doubled over the past 10 years compared to 5% increase per annum in developed countries.  China led the way almost tripling over this period, and as the country develops from an emerging market, workers began to demand minimum wage levels.

This rising wage inflation is not isolated to Asia, South America has also seen similar rises, and as workers demand higher pay, their demands then mature for better consumer products, food and standard of living.  This is the common path from an emerging market country to a developed.  However there are many obstacles to overcome, read more on this in Rural Expansion and the Control of Urbanisation.  

For companies based in the US or other developed nations it may become more economical to bring manufacturing and production back to their country.  As wages become closer between the countries, after eradicating shipping costs, the difference is not that high.  With energy prices reducing in the US this is becoming more common, and reshoring may gather further pace.

Whilst wages have increased significantly, one must remember it started from a lower base, Asia is still a very cheap place to produce, and many have shifted from China, to South East Asian countries such as Indonesia, Vietnam and Thailand, where the minimum wage in Thailand is 300 Baht a day, a little over $10.

There will undoubtedly be a lot of change in emerging market economies over the next 10 years, however as a large proportion of growth is derived from manufacturing and production of goods for overseas companies, one must remember to maintain the competitive edge otherwise growth may evaporate.

Active vs Passive Investing

A common question people ask is, "What are better, active or passive investments?" Many investors see no reason paying the extra annual management charges if they do not feel actively managed funds out perform the index they are investing in.

Let's take North America as an example, I compared the S&P 500, (the top performing US index over the past 5 years) against its respective actively managed sector performance.  The S&P500 has returned 13.35%, whereas the IMA (Investment Management Association) North America Sector returned 53.5%. It is evident here that the actively managed funds have outperformed.  This is down to a number of reasons.

Firstly fund managers have the ability to pick the best equities out of the index leaving those which will under perform.  Secondly, and possibly the most important is that they are able to manage risk across the portfolio.  Selecting not only the best funds, but the best sectors, one is able to diversify risk across the fund.  Further analysis into the correlation of each equity held you can combine the weightings together to ensure optimum protection on the downside whilst being able to capture growth through stock selection.

The most common way of purchasing an index is through an Exchange Traded Fund (ETF), these are cheap ways of accessing a basket of companies.  There are usually two types of ETF, those that invest the money in the physical asset, in this case the constituents of the index, or those that swap performance of a basket of assets for that of the index.  The later is considered to be less desirable as many investors do not like holding something that isn't the asset they have paid for.  Never the less, these offer the closest replication of performance as there is very little tracking error (the difference between the actual index performance and the fund).  With the synthetic ETFs most offer a collateralised swap, worst case if the swap counter-party fails, you are usually guaranteed to receive AA rated bonds.

For long term investing over 20+ years many see it beneficial to hold just the index, it is a cheap and effective way to gain exposure to a country or market, it requires less research and in some cases will out perform managed funds.

However, for the best returns I would recommend actively managed funds, these will offer the best downside protection which would have been important over the past five years and if you select correctly the best returns.  Taking the earlier example of the US equity market, the S&P 500, recently hitting new highs has returned around 1303% since 1985.  Compare this to our North American equity fund in Top 10 Funds of the Month, Gorden Grender who runs GAM North American Growth has returned 2700%.  So which one would you rather have?

Actively managed funds need to be reviewed as there will undoubtedly be funds that under perform the index, so pick wisely.  

For those of you who are not convinced by this argument  a number of providers offer cheap access to equities and other asset classes via both ETFs and a handful of unit trusts.  Namely Vanguard, BlackRock's Ishares and Deutsche Bank's db X-Trackers

Equity Markets Fall...

Global equity markets tumbled on Friday amidst a raft of bad news and political uncertainty.

Volatility in markets, until this week had been fairly benign, even through the Cyprus crisis. However, this week has seen a spike in volatility and led to big losses globally. So what has caused this steep fall?

Well there has been a run of poor data out of the U.S. this week. Manufacturing growth and jobless claims all disappointed and these are both significant indicators and naturally caused a pull back in equities.

Commodities have been hammered this week largely on the back of news of large inventories. This indicates to markets that there isn't the global demand to purchase these raw materials thus highlighting growth is not at expected levels, again causing markets to fall.

Then behind this disappointing back drop North Korea tensions have continued to boil and the market has also re-trained its eye on Europe following the Cyprus crisis... all in all a lot of bad news for markets to receive over a week or so!

The question is what now? Well safe haven assets, such as Treasuries and Gilts have had a good week, as there has been a flight to safety. I've been caught out a little by this given the historical high price (and therefore low yield) of these assets, however it still seems they are attractive to investors at certain stress times in markets. Gold, it seems has not behaved as one would expect and has fallen as low as $1,550oz this week. This has occured even when equities have fallen off and geo-political tensions have risen - there could be a fundamental shift in gold currently, definitely something to keep an eye on (Gold).

So many equity investors will have experienced losses this week - but all in all equities have still performed strongly this year. The question is what will happen next week, will it be a case of a rise in equities as investors pile in at a cheaper entry price, or will investors continue to be spooked, sell equities to lock in profits and prices fall further? In these volatile times it's often hard to call....

Where and how to invest £1,000

I have been asked a fair few times recently, “I have £1,000 to invest, where should I put it?” For many just starting out, it is difficult to pick an investment.  Usually people would have just left this money in a cash ISA or a fixed term bond, however nowadays with interest rates so low, this is not really the best option.

Many banks offer stocks and shares dealing accounts, however this will generally limit you to UK listed equities.  If you haven’t done so already, Stocks and Shares ISAs (individual savings accounts) will be your best bet, they offer tax free investments up to the annual ISA allowance of currently £11,520.  So you will be well within this limit with the £1,000 investment. A number of providers offer competitive ISAs such as Hargreaves Lansdown and Standard Life.  From here you can invest in a wide range of investment funds at fairly competitive rates.

Next stop is choosing the investment.  Most ISAs limit you to investing £500 in each fund, or £50 monthly.  Generally a portfolio should have anywhere between 10-20 funds to ensure diversification across asset classes and markets.  However, you are fairly limited here with only being able to choose 2 funds. 

A number of asset managers have managed funds, which incorporates a range of asset classes.  By investing in a managed fund you have access to a diverse and structured fund to ensure management of your money is maintained even when you are not paying attention. 

These should provide you with a good starting point for your money. 

The next stop is working out how much risk you want to take, let’s for the moment classify this into three categories, Cautious, Balanced and Aggressive.  A Cautious investor would have anywhere between 20 and 60% in equities, Balanced 40-80% and Aggressive 80-100%. 

Jupiter Merlin Portfolio funds are a great place to start, winning numerous awards over the past 5 years, the team, Peter Lowry, Algy Smith-Maxwell and John Chatfeild-Roberts have one fund to fit each of the three risk categories above.

Jupiter Merlin Income (Cautious) - The fund aims to achieve a high and rising income over the long term with the possibility of capital growth.  Like all three of funds, they invest in a range of collective investments from OEICs, Unit Trusts to ETFs.  Currently the fund is positioned to the heaviest equity weighting permitted within this sector (60%) as they believe we are at the start of an equity bull market. Past performance is not one to doubt their abilities on, returning 43% over 5 years.  Top fund! Literally.

Jupiter Merlin Balanced (Balanced) - The fund aims to achieve capital growth with income over the long term investing in a range of collective investments.  They have shown it is possible to provide real returns over the past five years with this slightly more dynamic fund.  Past performance again has been top decile returning 40% over the past five years.

Jupiter Merlin Growth (Aggressive) - This fund is the most aggressive of the three, and it invests almost 100% in equity funds.  With a spread across global markets this fund has performed well over the past five years again top decile returning 41.5%.  

The continued top performance over the long term from the Jupiter Merlin team has earned them the top name in the managed fund spot and seen their funds reach over £9bn in size.  

Whilst these funds have a higher total expense (underlying fund costs) than others as it invests in collective investments rather than direct equities, it does not detract from the excellent performance demonstrated.  

Whilst you may want to select a managed fund that is able to diversify across asset classes, some Aggressive investors (especially young ones) would prefer buying 100% equity funds in specific markets.  For the longer term, emerging markets should offer the greatest prospects as these countries have the highest growth rates.  A number of funds therefore may be of interest; Invesco Perpetual Latin America, Pictet Russia and First State Global Emerging Market Leaders all target these areas.

You alternatively could pick one of the investment themes discussed or check out our top 10 funds of the month for more ideas.

North Korea - is it different this time?

This week has seen tensions escalate between North and South Korea, with North Korea declaring they are in a state of war with South Korea.

North and South Korea have been at loggerheads for over 60 years and it could be that this latest flair up is simply 'tough talk' from North Korea and the situation passes without any implications. North Korea has also become very vocal towards the U.S. and this week ratified a law regarding "counter-actions" against the U.S. which includes a nuclear strike. They also plan to kick-start their old nuclear programs. So is it different this time? Well the answer we hope is "NO"! This is simply North Korea flexing some muscle as they like to do, and no military action will occur. Both the U.S. and South Korea have been fairly quiet, which is a good sign and there does not seem to be any out of the ordinary deployment of troops by North Korea.

Nevertheless, tensions like this can spook markets, and that has happened with the South Korean market falling to five month lows, and the currency depreciating. Other risk (equity) markets around the world have also slipped which may be partly due to the uncertainty around the situation. In general wars, terrorist strikes or severe threats lead to equity markets falling off. Safe haven assets may provide investors with some solace during these times, and gold could be a good answer, although of late that hasn't proven the case with the gold price falling to YTD lows (Gold).

Geo-political trouble is always hard to quantify when purchasing stocks but it is important to be aware of possible conflict and make sure the reward is worth the risk.

Hopefully this will all blow over with no violence, but it is definitely something to keep an eye on! 

(Does anyone have a spare Nuclear bunker lying around?)

Interest Rate Decisions and Further QE

It has been a busy day today as central banks around the world announced interest rates and quantitative easing for this month .  Japan led the way as the new Bank of Japan governor Haruhiko Kuroda hit the ground running after his first meeting as they announced further bond purchases of 7 trillion Yen ($75bn) a month over the next two years easily beating market estimates of 4 trillion Yen.

This commitment is what the market wanted and they certainly have delivered, the Yen fell 3.4% against the USD following the announcement and Japanese equity markets rebounded from earlier losses.  I expect many foreign investors will be eager to increase their exposure to the 3rd largest economy as other equity markets have hit a recent stand still.  This was certainly evident after the Japanese market closed up 2.20% the futures market rallied a further 2%. 

Back to Europe...Many were eager to here from Mario Draghi following issues with Cyprus and the worsening state of the Eurozone's economy.  Rates were kept the same as expected however, Draghi hinted at lower rates down the line if the economic situation did not improve.  His comments lacked the commitment many were hoping for as previous statements have been bold and provided direction.  The Euro weakened further as the hint of lower rates caught traders ears, however recovered slightly as the day went on.  A weaker Euro will help ease the blow for exporters, and Draghi mentioned an economic recovery should begin during the later part of 2013 (fingers crossed).

Mervyn King may have failed to convince the monetary policy committee once again that further quantitative easing(QE) should be implemented as interest rates and QE were kept level.  The UK's economy has been relatively flat since last month and data has failed to inspire either on the up or downside. 

An interesting time for equity markets, it highlights the importance of sector allocation, some markets this year I expect will massively outperform others so pick wisely.

Trouble in Egypt

A country that has fallen off many peoples radar is Egypt.  This used to be a top holiday destination and attractive investment area before Hosni Mubarak, the President for over 25 years was ousted by a public uprising.  Since then this country has slipped into the Abyss, continuing uncertainty and lack of structure within the country has led to many holiday makers and investors to stay away.

The two biggest income streams for Egypt are tourism and foreign investment, the land is rich with natural resources, hot weather and beautiful seas.  The political uncertainty has acted as a deterrent and with many business contracts that were put in place during Mubarak's reign under dispute it is making it less desirable for the overseas investor.  Subsequently Moody’s downgraded Egypt to Caa1, on par with the likes of Pakistan.   This on the face of it seems unruly, however if you delve a little further into the state of the economy you may understand why.

For years the people of Egypt have received significant subsidies for things such as oil and food, but as global costs rise this pressure has been passed onto the government.  Economic growth prior to 2011 was around 6%, an attractive level, however this has fallen off significantly as demand for Egypt has dissipated.  This economic weakness has been amplified by the weakening local currency.  This year alone the Egyptian Pound has fallen off 7% making those sought after imports such as fuel and food more expensive.  As such petrol shortages are now common throughout Egypt.  Price rises have been so severe many distributors are not buying the allowed quota as they fear the wrath of their customers when they see prices have risen so much.   Rolling blackouts throughout Cairo are not uncommon as during the midst of summer weather energy demand is in full throttle as people use air-conditioning. 

With many structural and political issues still to overcome there have been talks with the IMF about an emergency loan of around $5bn to keep things ticking.  The key importance is to make the country more stable and attractive for foreigners and generate demand again.  Political issues over business contracts certainly are not the way forward however, we may see heavy royalties inflicted on those already situated as a method for government income generation.

A number of companies operating in this area, such as Centamin (gold miner) are currently very cheap, however like many their mining contract is under dispute.  There are certainly  opportunities, however investors will most likely keep a close eye on over the coming months before jumping in.

The market is waiting for that bold statement, “We are ready for business”.

1st Quarter 2013 Round Up

For most investors Q1 has probably exceeded expectations and equity elements of portfolios should have performed strongly. Almost all markets seem to have advanced during this quarter, from Emerging Markets to Developed Markets, with the U.S. and surprisingly to many, Japan performing strongly. Currencies, like equity markets have moved considerably, with USD strengthening against a basket of most global currencies, and Sterling weakening as many consider the currency overvalued given the precarious state of the UK economy (Currency). 

The seemingly relentless climb in global equities did dissipate in March however. The Cyprus crisis helped to remind investors that although the global outlook may be improving there are still considerable headwinds that could stall the recovery. Although Cyprus is only a small nation, it did cause global investors to pause, with some taking the opportunity to lock in profits and sell equities. 

So what can we expect for Quarter 2? Well I think there is still a demand for equities from investors, coupled with a bearish view on developed world debt, particularly government debt, and as such I expect money to continue to flow into equities, and any dip maybe seen as a buying opportunity (buying on the dips) for investors. Although I expect equities to advance further, I do think there will be volatility along the way, and one must have a strategy to manage this. If you take a long term view, then this short-term volatility may not be an issue; others however may look to using hedging techniques to help manage volatility. I think we will continue to see QE from the US, UK and Japan which should be favourable for equities and I also expect rates to remain unchanged, given both inflation and growth is still low.

Q1 has hopefully been a profitable quarter for you as an investor and hopefully Q2 will be similar. However it is important to be aware of the headwinds and position your portfolio accordingly. 

Equity Markets Take Time to Reflect

Global markets paused as a number of countries celebrate Easter. Economic data out of Asia disappointed as PMI from China undershot estimates. The Yen strengthened against all major currencies as investors continue to wait for signs of economic improvement. As the earnings season for Q1 begins we may start to see signs of companies relishing in the cheaper local currency, however for now there seems to be little indicating this first round of QE has had much of an impact.

Elsewhere, the U.S. manufacturing data came short of analysts expectations as economic improvements showed how fragile they actually are. As fiscal cuts begin to bite, consumer demand may halter slightly during the mid part of this year.

The recovery in China is there, however not at the level many would hope for, commodity prices have fallen off somewhat amid fears of falling demand. China is one of Japan's largest export market and it fails to instill confidence that economic recovery will be driven from foreign demand.

A lot of data out again this week, Draghi is due to speak on Thursday after the ECB rate decision and much light will be shed on the state of the Eurozone's economy following the issues with Cyprus. Furthermore, the BoE are due to announce possible further quantitative easing on Thursday as George Osbourne failed to inspire during the Budget a fortnight ago.

Certainly an interesting time for equity markets, as the clocks go forward in the U.K everyone awaits the hopefully prosperous and sunny summer ahead.