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Infrastructure Will Be Hot — But Not Yet

The Trump trade has begun to languish, but it isn't necessarily over.
Guild Investment Management ( is a registered investment advisor located in Los Angeles. The company was founded in 1971 by Montague Guild. We provide fully discretionary investment portfolio management services to U.S. and foreign individuals and companies with personal, pension and IRA accounts. We study the world, do the homework, make strategic asset allocations, and make buy and sell decisions so our clients don’t have to do this work.
Guild Investment Management ( is a registered investment advisor located in Los Angeles. The company was founded in 1971 by Montague Guild. We provide fully discretionary investment portfolio management services to U.S. and foreign individuals and companies with personal, pension and IRA accounts. We study the world, do the homework, make strategic asset allocations, and make buy and sell decisions so our clients don’t have to do this work.

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In February, as heavy rainfall brought an end to California’s drought, the state’s relief was overshadowed by the failure of spillways at the Oroville Dam. With 200,000 residents in the path of a potential flood, the episode starkly highlighted the poor condition of much critical infrastructure — not just in the Golden State, but around the country.

That was still in the new U.S. administration’s early days. Although infrastructure had been a key plank in the Trump campaign, and although observers were hopeful that a robust infrastructure program could gain bipartisan support, the new administration’s legislative roadmap wasn’t yet clear. As that agenda developed, and other items (such as healthcare reform) were prioritized, hope waned that a big infrastructure push could be initiated in the near future. Industrial, construction, and materials companies whose stocks had benefited from the “Trump trade” began to languish.

The Indxx U.S. Infrastructure Development Index, unlike some infrastructure indices which are heavily weighted to telecoms and utilities, tracks stocks from a wide range of infrastructure-related industries. While it outperformed the S&P strongly in the four months after the election, it has subsequently lagged.

Source: Bloomberg

U.S. Infrastructure Still Gets a “D+”

Since we wrote about the subject in February, the American Society of Civil Engineers (ASCE) has published its quadrennial “Infrastructure Report Card.” 2017’s report card shows little change from 2013 in its broad outlook on the state of America’s infrastructure, still meriting a “D+” grade. ASCE sees a total gap in needed infrastructure spending over the next decade of $2.06 trillion. The graph below shows how that gap breaks down according to infrastructure categories.

Some data points from this year’s report:

    • ASCE estimates that failing to address the infrastructure shortfall will result in $3.9 trillion in losses to GDP and 2.5 million lost jobs by 2025.
    • 9.1% of bridges in the U.S. are rated “structurally deficient” (interestingly, all of the bottom five states by number of deficient bridges went to the Republicans in November, and some were significant swing states).
    • 17% of dams are rated “high hazard potential.”
    • 3,571 power outages were reported in 2015, with an average duration of 49 minutes.
    • 53% of Americans live within 3 miles of a hazardous waste site.
    • 20% of levees in the U.S. Army Corps of Engineers program are rated as “moderate risk” or worse.
    • Poorly maintained and over-congested roads caused 6.9 billion hours of delay for U.S. drivers in 2015 — 42 hours per driver on average.

How to Address Infrastructure Needs Efficiently and Quickly

The problems pointed out by the ASCE have the advantage of being facts — not Republican facts, Democratic facts, or alternative facts. Addressing those facts will benefit the constituents of both blue states and red states.

Although the new administration’s strategy for pursuing its legislative agenda is still in flux, it has recently signaled a resolve to tackle infrastructure in a timely fashion. Last week, Mick Mulvaney, director of the Office of Management and Budget (OMB), began to talk up infrastructure again — specifying the President’s target for spending (a trillion dollars, as before) and suggesting that it will be ready in the fall — although it might be earlier if it comes as part of a comprehensive deal with Democrats on other big-ticket issues. Mulvaney also indicated that, as had been previously mooted, the President would seek to draw in the bulk of the funds — about 80% — from private capital, structuring the program as public-private partnerships (PPPs).

Data Source: ASCE

Public-Private Partnerships

PPPs allow public agencies and private enterprise to work together to supply infrastructure, leveraging the strengths and compensating for the weaknesses of each.

PPPs sit at the intersection of two big needs. On the one hand, the country needs much more infrastructure investment than is likely to be met by public funding alone, as the ASCE report card indicates. On the other hand, pension funds are desperate for the kind of steady income that can be generated by many infrastructure projects — especially in a world of low bond yields.

Bringing private capital into the infrastructure equation can offer a host of other benefits. Everyone knows the jokes that are made (in the U.S., at least) about the postal service and the local department of motor vehicles. Suffice it to say that the private sector is often better able than government to provide service quality at a level the public appreciates.

Further, because PPPs typically bundle many activities together — design, construction, and ongoing service provision, for example — they are often more able to achieve cost-saving synergies and economies of scale. They can also be completed faster — one study in the UK showed that 24% of PPP projects run late, compared to 70% of public-only projects.

PPPs also benefit from effective risk sharing. They can be structured in such a way that the public and private parties take on the risk types that are appropriate to them — and against which they’re most able to defend the project.

Despite these clear positives, PPPs come in for a lot of criticism. As soon as members of Trump’s team began talking about basing the infrastructure push on PPPs, skeptics began pointing out their potential weaknesses. One of the most frequently mentioned is that a lot of the most-needed infrastructure doesn’t generate the kind of revenues that private investors need. But the details of PPP projects can often address that problem in creative ways. For example, critics note that toll roads can become oppressive and generate public resentment. But PPP road projects can also generate revenue through “shadow tolls” funded by the government through other mechanisms than on-site toll collection. The history of PPPs shows great potential for creative problem-solving of this kind.

Interestingly, the idea of private involvement in public infrastructure generates anxiety everywhere — but different countries worry about different things. The British are happy with their privatized water companies, but fearful about privately operated toll roads. The Australians, on the other hand, are very accepting of their private toll roads, but highly skeptical about private water companies. It all seems to depend more on culture and political history than on the potential problems with PPPs. Such problems as there are seem to depend on technical aspects of the contract process, rather than on inherent weaknesses of the model.

For this reason, we’re hopeful that a big public-private infrastructure push can happen, and can garner bipartisan support, if done intelligently. And here, there’s political risk: can the Trump administration live up to its leader’s dealmaking reputation, and the skill sets of some of its most capable members, and “make a deal”?

Investment implications: Infrastructure will become an excellent investment area; just not yet. Until we see progress and can gauge the emergence of a majority consensus among lawmakers, we would not be aggressive in the infrastructure theme on the basis of U.S. policy. When legislative progress becomes more tangible, investors can seek exposure to big-cap industrial, materials, and construction companies. Some of these companies may begin to outperform on the basis of favorable trade actions, which the Trump administration can implement unilaterally, and could merit investors’ attention on that basis even before infrastructure plans mature.

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Any change significant enough to matter draws vigorous opposition from those who depend on the status quo.
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