Politics has never been far from investor’s minds over the last couple of years and this week market strategists have had the implications of Teresa May’s speech in Florence signalling a shift in tone on Brexit, the German elections which saw a relatively strong performance by the Eurosceptic, anti-immigration AfD party and Shinzo Abe’s decision to call a snap election in Japan to mull over and opine on.
But closer to home, yesterday’s speech to the Labour Party conference by Shadow Chancellor John McDonnell, was noteworthy for investors in infrastructure investment companies because he pledged to 'bring existing PFI (private finance initiative) contracts back in-house'. PFI contracts where private finance is brought in to develop and manage public infrastructure have been used across a wide range of sectors including roads, bridges, prisons, schools and hospitals. McDonnell has also pledged to nationalise rail, water, energy and the Royal Mail, marking a complete break with the orthodoxy in economic management of the last three decades.
This pledge is likely to unsettle investors in the UK listed infrastructure fund sector which collectively is valued at £11 billion. Investment companies which invest in direct infrastructure projects have become hugely popular with investors in recent years offering a combination of attractive yields underpinned by long-term contracts – typically 20 to 25 years – with inflation-proofing often built into agreements. A key attraction has been the perceived stability of having UK (and other) governments as counter-parties. Such has been the demand for these assets, prior to yesterday’s announcement the average listed infrastructure fund was trading at a 14 per cent premium to NAV.
Yesterday’s announcement provided few details of how much such a move would cost the public purse – but is likely to run into the tens of billions of pounds - nor indeed the methodology for financing this flurry other than the suggestion that it might be paid for by issuing yet more debt in the form of Government bonds. Of course it is very cheap to issue debt at the moment, but this already seems set to rise as the Bank of England has adopted a more hawkish tone on interest rates and in the hypothetical scenario that a hard-Left government comes to power with an economic programme that the markets are sceptical about, the cost of issuing long-duration debt would likely rise significantly.
It is important to point out that within the UK listed infrastructure investment companies universe, portfolios vary in their exposure to UK PFI/PPP and other regulated investments and in recent year many funds have moved away from PFI due to a lack of new projects. Those with the highest headline exposure to UK PFI are HICL Infrastructure and John Laing Infrastructure. The investment companies with the lowest exposure to UK PFI are 3i Infrastructure and BBGI.
There are of course of a lot of unknowns here and no certainty that such a crowd pleaser for the Labour Party conference will ever be put into action. The costs of buying PFI partners out of legal contracts will likely be enormous in their own right, let alone alongside other populist but costly policy commitments such as scrapping university tuition fees. And then of course once PFI investors are compensated the tax-payer would still need to bear the cost of the state managing these projects directly. But this certainly does add to the political risks on these types of assets, which could well bring the eye-popping premiums in the sector under pressure, especially in the event of another General Election being called.
Those considering adding some infrastructure exposure to their portfolio, might instead consider a global listed infrastructure fund instead. Our preferred fund is the Lazard Global Listed Infrastructure Equity fund which invests in companies with exposure to monopolistic projects, inflation-linked revenues and low demand volatility. Some 63 per cent of exposure is in Continental Europe and 15 per cent in the US, with just 6.7 per cent in the UK. Examples of holdings in the 25 stock portfolio include Atlantia which operates 5,000 km of toll motorways across the globe as well as airports in Italy and France, French firm Vinci which designs, finances and builds infrastructure and manages concessions globally and US rail freight firm Norfolk Southern. While the current yield of 2.37 per cent on the fund does not compete with >4 per cent yields found in the listed infrastructure investment companies sector, there is no hefty premium to pay and the fund’s overall objective is to deliver a total return of Consumer Price Inflation + 5 per cent pa on a rolling five year basis.
Jason Hollands is managing director at Tileny Bestinvest.
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