How to assess whether infrastructure funds can be a useful portfolio asset

The concrete word “infrastructure” is regularly bandied about in conversations that cover the more nebulous term “productivity,” as economists and analysts alike try to fathom why certain economies and workforces seem to be more efficient than others.

But building new facilities or upgrading old ones can be expensive and time-consuming, so from the perspective of politicians this is a solution that may lie beyond their personal time horizon, which is likely to be dominated by electoral cycles and a desire to preserve their own seat or post.

For patient investors, however, infrastructure can play a role in a well-balanced portfolio, at least if history is any guide and the past few weeks can point to plenty of noteworthy developments in the sector:

• First-half results from quoted investment company 3i confirmed that the FTSE member had raised £830 million for two new European infrastructure funds and made its first ever North American infrastructure investment, Smart Carte (a specialist in luggage carts and electronic lockers).
• Fund management giant M&G launched a Global Listed Infrastructure Fund to target quoted infrastructure owners and infrastructure-related securities (but not directly in the projects themselves).
• Tri-Pillar Infrastructure Fund, managed by CAMG, announced plans to raise £200 million and list on the London Stock Exchange, targeting an annualised dividend yield of 4.5% by investing directly in a range of existing and new-build infrastructure projects.
• Shares in the John Laing Infrastructure Fund (an investment company quoted on the London Stock Exchange) wobbled when the management team declared that in the event each and every one of its Private Finance Initiative (PFI) projects were terminated by a Labour Government, it would receive compensation worth some 86% of the assets. That took the shares back to pretty much parity with the net asset value per share figure (NAV) after a consistent spell of trading at a lofty premium.

John Laing Infrastructure fund raised the issue of regulation and political intervention

Source: Thomson Reuters Datastream

It does not appear to be Labour Policy to take every PFI deal back under Government control, just those where there is a perception of poor value for money (although how that would be defined remains open to question).

But the John Laing Infrastructure fund commentary does show that infrastructure, like any potential investment, is not win-win and careful research must be done before investors put any capital to work (and at risk).

In sum, this column would suggest there are six important tests which must be carried out:

• The benchmark followed by the fund and fund manager (if any)
• Its geographic mix and the consequent potential for political risk
• Whether the fund invests in quoted securities or actual infrastructure projects
• The fund’s likely performance profile if interest rates continue to rise
• The yield on offer
• The costs charged by the fund provider and whether they represent value for money, given the historic return and yield profile and investors’ view on potential future returns

Best performing Equity Infrastructure Funds over the last five years

Source: Morningstar, for Sector Equity Infrastructure category.
Where more than one class of fund features only the best performer is listed.

Best performing Infrastructure companies over the last five years

Source: Morningstar, The Association of Investment Companies, for the Sector Specialist: Infrastructure category
* Share price. ** Includes performance fee

Best performing European Large-Cap Blend Equity ETFs over the past five years

Source: Morningstar, for Sector Equity Infrastructure category.
Where more than one class of fund features only the best performer is listed.

One track minds

Spending time stuck on a train owing to old track, in a car owing to inadequate roads or in an airport lounge owing to a limited number of runway slots can all in their own way hold back productivity (and thus growth).

Worthwhile, effective infrastructure investment is therefore seen by some as one potential avenue toward improved economic growth, especially if it is funded by cheap borrowing, given the low prevailing interest rates in the West.

Yet some view any kind of further borrowing as anathema, preferring to let the private sector take the strain and make (regulated) returns on the back of its investment.

This creates potential opportunities for investors, as the infrastructure sector has several potential selling points:

• It taps into many themes – population growth, productivity, urbanisation – and it does so via many industries and across many geographies. As such, it provides diversification by stock, sector and continent.
• Infrastructure projects tend to benefit from relatively guaranteed (and potentially growing) demand. And while regulated, they often come with some degree of inflation protection to attract the initial investment. This means infrastructure funds can provide advisers and clients with some degree of inflation protection too, via rising profits and rising dividends.
• Infrastructure funds can therefore potentially cater for those investors who are looking for long-term capital growth, income or a mix of the two and potentially do so with lower volatility, given the fairly steady nature of demand for their underlying assets.

Quick tests

These facets may appeal to some investors, especially those with a long-term time horizon, but checks must be done on the individual funds which can be used to glean exposure.

Beyond the usual important considerations of cost and whether the fund represents value for money, the yield on offer and whether the collective invests in quoted securities or actual infrastructure projects (as this can affect liquidity and thus the target returns required to justify exposure) there are three more quick checks that must be made:

• Benchmark. This will determine to some degree the shape of the portfolio, unless the fund manager is willingly benchmark agnostic. Alex Araujo of M&G Global Listed Infrastructure Fund points out most of the key infrastructure indices are heavily exposed to utilities and transport stocks, which may or may not be a good thing at certain parts of the cycle. This is why Araujo’s new fund has defined its own investable universe to avoid the dangers of investing in just low-growth, fat-yield utilities and offer the chance to also invest in new, evolving areas such as electronic payments, data centres and satellites.

Infrastructure benchmark indices can be slanted toward certain sectors and industries

Source: M&G, index providers

• Interest-rate sensitivity. This issue of sector exposure becomes particularly important when the role of interest rates is taken into account. Infrastructure stocks and funds can struggle, at least initially, when interest rates start to go up. This is because certain infrastructure stocks, especially utilities, are often treated as bond proxies. When interest rates go up, bonds tend to go down, as investors take money out of fixed income and stick it back into cash in search of the improved interest rate on – and lesser risk represented by – cash. The same can happen to utilities – as the gap closes between their dividend yield and the interest rate on cash, money can begin to slow out of the stocks and into bank accounts, again owing to the relative risk-reward calculation. The US Federal Reserve and Bank of England have both begun to raise interest rates – albeit very slowly and from a very low level – so this trend must be watched.
• Political risk. There is always the lurking danger that local politicians – or regulators – may decide that quasi-monopoly infrastructure assets are charging too much and crack down accordingly, or even threaten to nationalise the assets. Both policy options are under discussion in the UK now, let alone emerging markets, so investors need to check the geographic exposure of an infrastructure fund and weigh up this risk, no matter how remote it may seem.

As a final point, infrastructure funds, just like any other collective, are capable of underperforming global equity benchmarks at certain times of the economic and market cycle. Such potentially steady, low volatility assets could lag, for example, if animal spirits are running free and momentum and growth stocks are in fashion – which could frankly describe where we are now. Patience and a long-term time horizon are therefore always going to be required.

Russ Mould, AJ Bell Investment Director