Is it worth paying a premium for infrastructure funds?
On the face of it, investing in infrastructure seems like a wise move.
After all, you tend to get a steady stream of income for a long period of time. Assets such as ports, airports and toll roads aren’t going anywhere anytime soon, and due to their essential nature their earnings are both predictable and less likely to be hit by volatility. They also have an explicit link to inflation through regulation.
So when it comes to putting money into infrastructure investment trusts, which through one way or another put your cash into these assets, the relatively clear visibility on how much money they’re going to get from them means you’re likely to get a solid, reliable income that rises with inflation.
WHAT IS THE CATCH?
Most of these trusts at the moment trade at a premium, which means the shares trade at a higher price than the net asset value (NAV) of the fund.
These premiums may exist because the managers are being conservative on their assumptions over things like inflation and interest rates, says William Heathcoat Amory, an analyst at Kepler Partners.
So if it costs more to invest per share than the value of the assets, then why bother?
ALL DOWN TO YIELD
Amory says it’s difficult to find this sort of security of income elsewhere, and in comparison to gilts or other types of bonds the yields can be attractive, given the low interest rate environment we’re currently in.
‘The yields are pretty generous, and secure, so investors are happy to pay a premium for that,’ he says. ‘Institutional investors for example are happy to pay above net asset value. They are sophisticated investors, and they realise it’s not bonkers to pay above the NAV.’
So does that mean investors should simply look past the premium and just focus on the yield? Hold your horses.
He adds that paying a big premium at the moment could be quite dangerous, as sentiment can quickly change when it comes to investing in infrastructure due to the political nature of the asset class.
That means it is possible you could pay a big price now to get in and access that steady stream of income, but then all of a sudden there’s an election, Labour win and the trust’s shares start trading at a 10% discount.
When looking at infrastructure trusts, it’s important to consider how they would fare if there is a change of government, something which could well be around the corner given how volatile the current political climate is in the UK.
In the event of a general election, Stifel analyst Iain Scouller says the PFI sector would see the most nervousness due to that possibility of Labour going ahead with their stated aim of nationalising infrastructure.
If this were to happen, education and health projects would be the most affected, Scouller says, with those with higher exposure to these areas – HICL Infrastructure (HICL) and International Public Partnerships (INPP) – more affected than the others.
Also worth considering is the sensitivity of these trusts to interest rates and gilt yields, given their impact on the valuations of their assets.
Though given the exceptionally low base of both at the moment, Scouller believes a big rise wouldn’t be likely to cause big discount rates or consequent reductions in NAV.
He says, ‘In terms of sensitivity, we think the sector could certainly withstand a rise in the 10-year benchmark gilt yield from its current 1.2% up to 3% or possibly even up to 3.5% with little or no damaging impact on NAV valuations.’
Sequoia Economic Infrastructure Income (SEQI)
This trust yields 5.4% and while the shares trade at a 10.2% premium, this is not the highest among infrastructure investment trusts.
It also has the lowest fees in the sector, with an ongoing charge of 1.03% a year.
The trust offers exposure to a globally diversified portfolio of economic infrastructure debt, which includes sectors like transport, technology, utilities, media and telecoms, power, accommodation and renewables.
In a research note last November, Winterflood analyst Kieran Drake said the infrastructure debt sector has historically had lower default rates and higher recovery rates than the broader debt sector.
Sequoia is also considering a new share issue this year as it continues to diversify its portfolio.
HICL Infrastructure (HICL)
One option for investors seeking a progressive, quarterly dividend-paying investment with scope for capital growth is HICL, trading at a premium of just 3.7% to NAV, far lower than the 16.5% for BBGI (BBGI) for example or the 22.6% for 3i Infrastructure (3IN).
This could be because it is more at risk if Labour win a general election and utilities get renationalised, as it holds more of them than the other funds.
But even if this did occur, Scouller says investors should expect only modest ‘haircuts’ to portfolio valuations, and HICL stated in November last year that the amount contractually payable in the event of nationalisation would be around 98% of the portfolio value.
At 4.9%, its yield is also higher than the two aforementioned trusts, and HICL is projecting dividend growth in the next year or two.