Value appears as interest rate rises and renationalisation threats take the shine off infrastructure trusts.
With interest rates at record lows, infrastructure trusts looked like the perfect solution. Paying an income of around 5 per cent plus, from a portfolio of government-backed assets such as hospitals and schools, they were a good option in an income-thirsty world. The trouble is, everyone else realised it too. The trusts moved to double-digit premiums and started to look unappealingly expensive.
More recently, however, the sheen has dulled. Labour’s pledge to renationalise infrastructure assets such as water and rail has hurt those trusts with a significant weighting in the UK. Elsewhere, a shifting interest rate environment has also made the predictable yield of infrastructure trusts less appealing. This has seen premiums slip and canny investors have started to re-examine the sector.
Professional buyers have also joined the mix. The John Laing Infrastructure Fund was snapped up by a consortium of fund managers for £1.4 billion in August this year, as institutional investors such as pension funds take a growing interest in infrastructure assets. Its long-term income stream is a good option for pension schemes with retirements to fund.
The question is whether this recent fall in premiums has created any bargains. It should be noted that the political problems haven’t gone away. At its recent conference, the Labour Party continued its commitment to renationalising water, energy, the Royal Mail and the railways.
Jason Hollands, managing director of business and communications at Tilney, says: ‘In the near term there are clearly some political headwinds for UK infrastructure investment vehicles given Labour’s policy pledge to take UK public sector contracts back “in-house”. How easy that would be able to do in practice is a moot point, as attempts to cancel legally enforceable contracts could well embroil a future government in years of legal wranglings. The collapse of Carillion has also exacerbated some of these anxieties around infrastructure.’
The direction of interest rates also remains a problem. While interest rates remain at 0.75 per cent in the UK, the direction of travel appears to be higher. This inevitably devalues the income available from infrastructure trusts. Gavin Haynes, investment director at Whitechurch Securities, says: ‘These trusts tend to show interest rate sensitivity and act a bit like a bond proxy. Although our view is that interest rates will remain lower for longer, these trusts may not go at the same speed.’
Nick Greenwood, manager of the Miton Global Opportunities trust, suggests there is no glaring opportunity in infrastructure funds. At one point he believed there might be an opportunity as interest rates rose, and there was a glut of new issuance that needed to be absorbed by the market. This should have pushed prices lower and yields higher.
However, the acquisition of John Laing Infrastructure has helped keep prices high as buyers recognise that there are institutional buyers interested in the assets held by these trusts. ‘Life companies and pensions funds are more natural buyers for these assets and there may be a transfer of ownership over the longer-term. Now the market has recognised that these buyers exist, it has pushed up prices.’ Certainly, some trusts are back up to double-digit premiums again.
Having said that, these trusts still have a number of appealing features for a certain type of investor. As Hollands points out, they have ‘attractive yields, an element of inflation-proofing [as this is typically incorporated into contracts] and low correlation to both other asset classes and the economic cycle. Another factor is that across the globe there is a shift away from central bank-driven monetary stimulus programmes, towards greater emphasis on fiscal policy including the stepping up of infrastructure investment.’
Also, there is a lot of choice in the sector. At one end is HICL Infrastructure, which is focused primarily on UK assets, holding Southmead Hospital, an acute care facility in Bristol, and the Oasis Academy Shirley Park in Croydon. At the other end are trusts such as Utilico Emerging Markets, which is focused on infrastructure in the undeveloped and developing markets of Asia, Latin America, Emerging Europe and Africa. There are also trusts focusing on renewable energy infrastructure such as wind farms and solar panels. While most trusts have an income focus, each has slightly different underlying characteristics and offers something different for investors.
Infrastructure trusts may not be cheap, but they are cheaper than they were and there is no sign of demand flagging. Institutional buyers are likely to provide some support for the market, and it offers more choice than might initially be apparent. Interest rates may have risen, but infrastructure trusts still command a significant premium, with many paying an income of 5 per cent or higher. That is better than an equity income or corporate bond fund. As such, the sector retains some appeal.
Utilico Emerging Markets (UEM)
Infrastructure development remains key to unlocking economic development in emerging countries. The World Bank states it takes 12 days and $625 to export a container from Egypt; transporting the same container from the Central African Republic takes four times as long and costs almost nine times as much.
A report from consultancy McKinsey in October 2017 showed $69.4 trillion of global infrastructure development in 2017. Of this, China was the key beneficiary, attracting 34 per cent (up from 29 per cent in 2016) of overall investment, but other emerging market countries continue to lag – Latin America received just 6 per cent, and India just 8 per cent.
There is a clear need for infrastructure investment and Utilico Emerging Markets remains one of the only funds to target it. Manager Charles Jillings believes there are real merits for investors: ‘It is a really attractive asset class. Emerging market infrastructure companies typically offer long-term, cash-generative operations which are paying strong dividend streams.’
He adds: ‘Some investors may have the perception that infrastructure is less “exciting" than other more volatile sectors, but these are assets which are geared into the rise of middle classes. With higher consumption, more goods are shipped through ports and via toll roads, and millions of new tourists travel every year through EM airports.’
However, he admits there are risks – a change in political regime, less-developed legal structures and corruption among them. ‘A significant level of due diligence is necessary to ensure that these [dividend streams] are sustainable.’
There are countries where it is impossible to invest. There are also countries where the geography can greatly hinder development – for example Colombia, which is very mountainous so restricts rail network development. As specialists, the managers aim to navigate these difficulties.
The Utilico trust sits not in the infrastructure sector, but in the global emerging markets sector, which makes comparisons with its peers difficult. It is up 33.5 per cent over three years (37 per cent in NAV terms), which lags the emerging markets sector but compares favourably with much of the infrastructure sector. Only John Laing Infrastructure and 3i Infrastructure are ahead over the same time period. Currently holdings include a ports operator in the Philippines, a gas distributor in China, an airport operator in Malaysia and a railways operator in Brazil. The current dividend yield is just under 4 per cent.