Infrastructure funds have surged in popularity among income-seeking investors in recent years. These vehicles offer a steady, reliable and often inflation-linked income stream at a time when interest rates have remained stubbornly low and such attributes have been particularly hard to find.
But a series of blows to the sector this year has seen many of these investments fall from double-digit premiums to wide discounts as investors have questioned the prospects for the future. The collapse of high-profile outsourcing firm Carillion brought a black cloud over the sector at the start of the year and, more recently, the announcement in the November Budget that the Government will put an end to private finance initiatives (PFI) contracts has left some questioning whether infrastructure funds can continue to deliver.
Matthew Hoggarth, head of research at Thesis Asset Management, says: “The PFI projects ticked all of the boxes: predictable because the cash-flows were defined contractually and usually inflation-linked, reliable because they were backed by government, and long-term because the concessions usually lasted for 25 to 30 years.”
PFI Out of Favour
PFI was introduced by the Conservatives in the 1990s and expanded significantly under the Labour government between 1997 and 2007. These contracts allowed the government to build hospitals and schools without spending money up front. But the higher demand forced up the cost of the contracts with private companies and after the financial crisis in 2008 the Government started to reduce its use of them. Indeed, the Treasury has said that PF2, the latest iteration of PFI, has only been used for six projects since 2012.
Gareth Gettinby, investment manager at Kames Capital, says the scrapping of future projects makes little difference to the investment case for infrastructure and points out that it is reassuring that Chancellor Philip Hammond has said the government will honour all existing contracts.
Gettinby says: “Many of the listed infrastructure vehicles do have sizeable, although declining, investments in PFI assets. However, a number of them are continuing to increase their holdings in overseas projects or non-PFI projects such as utilities, offshore, transmission and operating businesses and therefore diversifying away some of the risk already. In reality, there have been very few new infrastructure projects using this procurement.”
PFI projects are not the only infrastructure assets with appealing characteristics. Private assets such as those in the energy, transportation and service sectors can offer similar appeal. Hoggarth says the key is to look for projects where the cash flow does not ebb and flow with the economic cycle or the price of any commodity. For example, a gas pipeline would make a good asset as long as payments are not linked to the volume or value of gas transported, which would depend on the economy or gas prices respectively. Hoggarth adds: “For reliability, the source of the payments should be creditworthy or easy to replace with an alternative user.”
Investment Options
Eugene Philalithis, portfolio manager at Fidelity Multi Asset Income, points out that although PFI is being ended there are still ways that the public sector can use private funding for infrastructure projects. A regulated asset base model has been used for the Thames Tideway Tunnel and a contract for difference scheme is used for renewable energy projects.
He says investing through other infrastructure vehicles rather than directly into assets himself helps lessen risk and provide “better liquidity and diversification”, too. He adds: “We will be looking to see how these vehicles respond to a more important announcement in 2019, when the Government is due to publish a national infrastructure strategy.”
Ben Yearsley, investment director at Shore Financial Planning, says: “I’m a huge fan of infrastructure investments and don’t believe the end of PFI will have much of an impact on the sector. Infrastructure funds tend to invest more in assets such as roads, airports and mobile phone towers while trusts are often more esoteric, investing in renewable energy, doctor’s surgeries and social housing. Both have largely stayed away from PFI in recent years.”
While question marks linger over the sector, infrastructure does still have fundamental qualities which continue to make it an attractive investment. As well as offering useful diversification for investment portfolios, the primary attraction of these vehicles for many investors will, of course, be their yield.
Among investment trusts, GCP Infrastructure Investments (GCP) yields just over 6%, Sequoia Economic Infrastructure Income (SEQI) 5.4% and HICL Infrastructure (HICL)5.1%. Meanwhile, among funds, Premier Global Infrastructure (PGIT) yields 5.4% and unit trust VT Gravis UK Infrastructure Income 5.3% - these are levels of income that are hard to find anywhere else.
Hoggarth adds: “This is not a rapid turning off of the taps and neither does this signal the end of private sector involvement in providing public infrastructure. With growth slow by historical standard and public debt levels high, governments are constrained in the amount of public capital they can deploy so there will continue to be demand for private money to investment in these assets.”
