Sector spotlight: infrastructure trusts safe bet for rate rise

Strong cash flows, a favourable regulatory environment and decreasing market correlation make listed infrastructure investment companies attractive despite the threat of rising interest rates, say analysts at Canaccord Genuity.

In a report on the sector, the stockbroker claims fears that rising interest rates will adversely affect infrastructure trusts are misplaced as the sector boasts strong fundamentals.

One of its most redeeming features is its strong track record of consistent and increasing dividend payments, which Canaccord claims are 'comfortably covered by underlying cash flows' that are often underpinned by long-term inflation-linked contracts with public sector bodies.

In addition, the broker says that the renewable infrastructure sector also benefits from a stable regulatory framework and subsidies providing revenue stability in early years.

misplaced fears

With yields ranging between 5.5 per cent and 2.3 per cent, Canaccord believes that infrastructure trusts will remain attractive as and when the Bank of England does finally raise interest rates as hikes will be small and incremental.

'A key concern we encounter when discussing listed infrastructure is the potential impact of higher rates and there has been much noise recently about the timing of the first rate rise.

'We believe these fears are misplaced; it is difficult to envisage a scenario which would lead to a material rate increase or a return to pre-crisis levels. Mark Carney recently forecast that UK rates would stabilise around 2.5 per cent in 2017, a level which is half pre-crisis levels,' says the broker.

In addition, Canaccord claims that infrastructure funds offer good portfolio diversification with the correlation of the sector to the FTSE All Share index standing at just 0.12 per cent.

'Since March 2006, the [infrastructure] sector has delivered a shareholder total return of 95 per cent, comfortably ahead of the FTSE All Share total return of 58 per cent, and these excess returns have been achieved with two-thirds of the volatility,' says Canaccord.

These strong returns are reflected in valuations, with almost all infrastructure trusts currently trading on significant share price premiums to their net asset values (NAVs).

Shareholder total return on £100 invested, AIC infrastructure sector
Investment trust1 year3 years5 years
3i Infrastructure103.8126.0178.3
BBGI SICAV105.8N/AN/A
GCP Infrastructure Investment112.9136.7N/A
HICL Infrastructure Company114.7144.1168.5
International Public Partnership104.4129.7158.0
John Laing Infrastructure103.8126.9N/A
FTSE All-Share Index107.0130.3184.5
Source: company data

The most expensive on a relative basis is Bilfinger Berger Global Infrastructure (BBGI) trust, which is currently trading on a 17.6 per cent premium to its NAV at a share price of 119.5p. The only trust trading at a discount is Foresight Solar Fund, with shares priced 1.1 per cent below its NAV.

Reflecting on this, Innes Urquhart, investment trust research analyst at Winterflood Securities is less confident in the ability of infrastructure trusts to withstand a rate rise:

‘In our view, as interest rates rise, the dividend yield from infrastructure funds required by investors is also likely to increase. Inflation linkage aside, this could mean that demand for the asset class weakens. As such we see the current high premiums commanded by infrastructure funds as susceptible to volatility as the prospect of rising interest rates comes closer,’ he says.

However, Canaccord claims that in the case of closed-ended infrastructure funds, this traditional approach to valuation is 'far too simplistic'.

'Given the long-term nature, predictability and covenant of the underlying cash-flows, we believe that a yield-based approach to valuation is of equal importance and given the margin above risk-free investments, we remain wholly comfortable with current valuations.

'Indeed, if and when the music stops, the sector's ability to continue delivering absolute returns could represent significant value. We believe listed infrastructure should form a cornerstone of a diversified investment portfolio and we remain overweight,' Cannacord says.

In its summary of recommendations, the broker has 'buy' ratings on the following vehicles: BBGI, GCP Infrastructure, Greencoat UK Wind, HICL Infrastructure, John Laing Environmental, John Laing Infrastructure and Renewables Infrastructure.

Canaccord rates 3i Infrastructure as a 'hold', but has a 'sell' rating on International Public Partnerships, citing issues with balance sheet management and a debacle over incentive fees, which has 'done the company, sector or industry few favours'.

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