The third in a three-part series on infrastructure development globally and in Canada.

Investing in infrastructure is getting easier with the recent launch of a number of infrastructure mutual funds. But even though infrastructure is a good area in which to invest, you have to consider how suitable it is for clients.

The advantages of investing in infrastructure are healthy stable cash flow, relatively low risk, low correlation with stocks and bonds and a hedge against inflation. According to Ben Heap, senior manager with the global infrastructure group at UBS Global Asset Management in New York, returns tend to be in the 9%-12% range for the operational phase of infrastructure and higher for the construction period. At the same time, the real value of infrastructure assets rises with inflation, reflecting increasing replacement costs. In addition, fees charged to run infrastructure projects are indexed to inflation.

However, there are some disadvantages. Although risks are generally low, they do indeed exist. These include construction problems, financial overruns, environmental requirements and political issues. The private sector is generally better than government at bringing projects in on time and on budget, but sometimes there are problems. And any additional costs reduce returns.

Environmental risk is difficult to gauge because new regulations keep appearing. And even though political risk is an obvious issue in emerging markets, it can also raise its ugly head in the industrialized world. For instance, the private partners of Highway 407 toll route, on Toronto’s outskirts, had to take the Ontario government to court in order to change the toll-setting mechanism. The partners won, but it underlines the risk that’s inherent in virtually any political situation.

Another risk is lack of liquidity. It can take years to complete an infrastructure project; operational contracts can run anywhere from 30 years to 99 years. This time-line does not pose a problem for pension funds or insurance companies looking for assets and cash flow to match their long-term liabilities. In fact, some pension funds have been investing in infrastructure since the 1990s.

Retail investors, however, need liquidity. This makes the mutual fund format a great way to go, although there may be issues determining net asset values of infrastructure fund units, given the illiquidity of holdings, that can make it difficult for unitholders to exit the funds. As a result, Heap says, infrastructure investing is best for those in the early or middle stages of their careers who can hold the investment for 15 or more years.

Another option is to invest in publicly listed asset packagers, such as these Australian companies: Macquarie Bank Ltd., which has 11 country or sector-specific infrastructure vehicles, including Macquarie Power & Infrastructure Income Fund of Toronto; Babcock & Brown Ltd. which has Babcock & Brown Infrastructure Ltd.; and Challenger Financial Services Group Ltd., which offers Challenger Infrastructure Fund. All are involved in other activities but have a strong focus on infrastructure.

For clients who like to invest in Canadian companies but want global reach, there is Toronto-based Brookfield Asset Management Inc. Brookfield, which manages US$75 billion in assets, has a large portfolio of premier office properties and hydroelectric power generation facilities as well as transmission and timberland operations in North and South America and Europe. Brookfield has one income trust, Great Lakes Hydro Income Fund, in the infrastructure area.

A third option is to invest in the companies benefiting from the infrastructure boom, either through direct investment or through funds that invest in a basket of companies.

There are many companies in this category. A November 2006 report from UBS Ltd. in New York lists 23 top picks in global infrastructure and utilities, including Babcock & Brown. Most were energy-related utilities, including Canadian companies TransCanada Corp., Enbridge Inc. and TransAlta Corp.

Also on the list were Spain’s Cintra SA (Concesiones de Infraestructuras de Transporte) and France’s VINCI SA. They design, build and operate private/public infrastructure partnerships. Cintra operates toll roads while VINCI is involved in bridges, tunnels, carparks and roads. VINCI also takes a role in the financing. A third, Australia-based Transurban Group, focuses on long-term ownership and management of advanced electronic toll roads. It owns four Australian and U.S. toll roads and has at least a 50% interest in three others.

The UBS report also mentions two industrial conglomerates — Siemens AG of Germany and General Electric Co. of the U.S. Other highlighted firms include AREVA SA of France (nuclear power); Abengoa SA of Spain (water); Mota-Engil SA of Portugal (water, alternative energy and transportation); Bilfinger Berger AG of Germany (German infrastructure); Autodesk Inc. (computer-aided design software) of the U.S.; and Perini Corp. (power generation and transportation), also of the U.S.

@page_break@Sifting through all these global companies isn’t an easy task for clients. That is why mutual funds can be the preferred way to play infrastructure. “It requires a lot of monitoring,” says Ani Markova, infrastructure specialist and associate manager of AGF Canadian Balanced Fund at AGF Funds Inc. in Toronto.

AGF does not have an infrastructure fund, but its Canadian Balanced Fund has investments aimed at taking advantage of infrastructure spending. Among the companies Markova likes are U.S.-based Danaher Corp., a diversified manufacturing and technology company, and Canadian engineering firm Stantec Inc.

Winnipeg-based Investors Group Inc. does have an infrastructure fund — Investors Global Infrastructure Class, which launched in October 2002. As of Aug. 31, the Class A version had a 3.6% year-to-date return. Returns were 27.6% in calendar 2006, 7.8% in 2005 and 11.4% in 2004.

Patricia Fee, money manager at IG International Management Ltd. in Dublin, manages the broadly diversified fund. She picks industrial companies, telecoms and utilities involved in infrastructure spending. The fund’s target mix is 54% industrial, 25% telecoms and 21% utilities.

Fee mentions Finland-based Metsco Corp., a global engineering and technology company for the pulp and paper, rock and minerals processing and energy industries; and Holcim Ltd., a cement, crushed-stone, gravel and asphalt company in Switzerland.

“Lots of companies have full capacity and are expanding,” she says. “If you pick the right spots, there’s very high growth.”

In addition to the IG fund, a number of other infrastructure mutual funds and income trusts are offered in Canada:

> AIC World Financial Infra Income & Growth, established last January and offered by Burlington, Ont.-based AIC Ltd., invests primarily in companies located throughout the world that are engaged in the development, application, production and distribution of products and services that serve to underpin the infrastructure of the world’s financial services sector.

Holdings in the AIC fund include a number of financial institutions: American Express Co. of the U.S., BNP Paribas and Credit Agricole SA of France, HSBC Holdings PLC of Britain and UBS AG of Switzerland. It also has exchanges: Bolsas y Mercados Españoles of Spain, Deutsche Borse AG of Germany and Hellenic Exchanges Holding SA in Greece as well as credit services provider Nelnet Inc. and surety, title insurer Stewart Information Services Corp. of the U.S. and information supplier Thomson Corp. of Toronto.

> Criterion Water infrastructure Fund, launched in February and offered by Vengrowth Asset Management Inc. , of Toronto, invests primarily in companies involved in the water industry throughout the world.

> Macquarie Power & Infrastructure Income Fund is an income trust launched in 2004 that invests in essential North American infrastructure assets, with an emphasis on power. The current portfolio includes gas co-generation, wind, hydro and biomass power generation, and a 45% interest in Ontario-based Leisureworld Caregiving Centres, Canada’s fourth largest provider of long-term care or social infrastructure.

> Macquarie Nexgen Global Infrastructure Fund is a closed-end fund sponsored by NexGen Financial LP of Toronto. The initial public offering raised $91.2 million this past April and shares are still being sold.

The fund invests in publicly listed companies that own or operate infrastructure assets, including transportation, energy, water, telecom and social assets such as hospitals, schools and prisons. It may also invest up to 20% in unlisted private infrastructure funds, including entities managed by Macquarie.

> HSBC Infrastructure Co. Ltd., a subsidiary of HSBC Group, has long been an investor in infrastructure. It launched a global infrastructure fund that’s listed on the London Stock Exchange in March 2006. It initially provided exposure to 15 projects that had been developed and managed through their construction phases by the primary infrastructure team at HSBC Specialist Investments Ltd. All the projects were long-term concessions based on public-sector or government-backed revenue rather than usage for revenue. The fund now has 21 investments that are mainly operational. IE