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An Infrastructure Affair

From Mumbai to Beijing to Jakarta, the pace of Asia's economic boom is a frantic one. China’s economy is expected to grow by a whopping 11.4% this year. India is on track for an 8% expansion and Indonesia is projecting growth of 6.3%. Skylines bristle half-built skyscrapers, new factories and industrial parks are being built, and power lines clutter city streets. And with this expansion, comes the urgent need for roads, communication systems, housing and schools to sustain this economic growth – in short, infrastructure.

Infrastructure is the lifeblood and the nervous system of every successful economy. Highways, whether they are of the physical or electronic kind, make capital flows and trade in goods and services possible – they link people to economic activity. Access to good infrastructure systems encourages entrepreneurship, investment and overall economic activity.

Economic power house China has slated 20% of its gross domestic product (GDP) for infrastructure projects -- no small amount considering that China’s GDP for 2006 came in at almost $10 trillion. The World Bank estimates that the developing East Asian countries will need between $1.2 trillion and $1.5 trillion in investment in infrastructure until 2010, just to cope with economic growth.

It’s this connection between economy and infrastructure that should get investors excited.

Infrastructure Trusts vs Infrastructure-Themed Funds

It is essential to note that there are some fundamental differences between infrastructure trusts and infrastructure-themed funds. Infrastructure trusts exist as a stapled security, where related assets are bound together in an investment vehicle, and are traded as a listed security on a stock exchange. Such trusts exist primarily for the purpose of harnessing yield, as they pay out regular distributions to their unit-holders based on their revenue. They are often directly invested in assets that have been privatized by governments or in private sector assets.

For instance, Changi Airport in Singapore was recently restructured and will no longer come under the purview of the Singapore government. Instead, the airport will be run like a private business. In Malaysia, the North-South Expressway is managed by Plus Expressway Berhad, which collects tolls from every vehicle that uses the express-way. If shares of the companies that manage these infrastructure assets were bought and combined into an infrastructure trust, they would fall under the category of stapled securities. Investors can generally expect steady dividends rather than capital appreciation.

In the case of infrastructure-themed equity funds, fund managers have the discretion to buy into both infrastructure assets and/or companies. These funds have a much higher potential for capital appreciation. It is not surprising for these equity funds to look towards Asia as an important investment destination, given the region’s stupendous economic growth as a whole in the past few decades. Moreover, rapid industrialization is set to continue in economies like China and India.

Potential Risks

A country’s economic growth is adversely affected by events such as natural disasters, political upheavals or even acts of terrorism. These events, especially political upheaval, tend to take place developing countries. No matter how strong an economy’s underlying growth story may be, infrastructure-related businesses will not perform during these situations. Although the effects are temporary (infrastructure needs will eventually pick up) investors should note that infrastructure-related businesses are usually capital-intensive, involving large capital expenditure. When these events occur, an investor must consider the opportunity costs, while waiting for these infrastructure-related businesses to become profitable again.

Additionally, if the fund is largely invested in Asian equities, the level of volatility in his portfolio may already be similar to any traditional equity fund.

Thematic Thoughts

Infrastructure-themed equity funds are a potential way for the investors to participate in the world’s economic growth, particularly that of Asia. Many investment opportunities exist in companies involved in infrastructure-related businesses — especially if these companies have established a particular niche or possess an expertise in more complicated engineering projects such as the laying of oil and gas pipelines.

Although infrastructure is not yet an extremely popular investment theme, investors should not ignore the strong performance of such funds. If you believe that Asia’s economic growth will continue to march forward — with ASEAN nations like Indonesia, Thailand and Philippines looking set to be the next group of countries poised for good growth — having an infrastructure-themed fund in your portfolio may be something worth considering.

Send us your questions and comments to us at fundaffair@cnbc.com.