How you can build income through infrastructure investing
While infrastructure is still a relatively young asset class for investors, with pension and insurance funds starting to allocate in this sector, it has become increasingly popular in the last five years as investors seek new sources of income and diversification in their portfolios.
Following the financial crisis governments have also recognised the benefits of private investment, particularly at a time of rising government deficits.
What does infrastructure include?
Investing in infrastructure can either come under economic infrastructure or social infrastructure.
Economic infrastructure includes transport (such as roads, ports and bridges), utilities and renewable energy (such as power generation, water and sewage) and communications (such as cable networks, towers and satellites).
The social infrastructure umbrella meanwhile includes schools, healthcare and retirement facilities, as well as defence and judicial buildings, prisons and stadiums.
Why should I consider investing in infrastructure?
Infrastructure tends to have high barriers to entry (more on how to access the theme below) and monopoly characteristics but it tends to be backed by long-term revenue streams from local or central government.
Rob Morgan, pension and investment analyst at Charles Stanley Direct, says these long-term bond-type investments offer income yield in excess of inflation.
“A motorway river bridge can, for instance, be a near-monopoly route sometimes with scope for raising toll prices while the general growth in road traffic swells revenues anyway. Water, road traffic, broadband and other utility-style infrastructure tends to be fairly stable even during economic downturns, while government-backed projects for key buildings such as hospitals, schools and prisons can be uncorrelated to the wider economy altogether,” he says.
He adds the UK’s infrastructure needs expansion to handle the fast-growing population and he expects the investment sector to grow as it provides much-needed finance for vital projects.
As infrastructure assets typically require significant initial capital expenditure and have long operational lives, often spanning between 30 and 100 years, Sarasin & Partners says they’re usually regulated or underpinned by long-term contracts which “usually provide a reasonably predictable income stream”.
For Darius McDermott, managing director of Chelsea Financial Services, the main benefit is that the infrastructure sector tends to be less volatile than the wider stock market. He adds there was a sharp uplift in performance and premium in the days post-Brexit and post interest rates being cut to 0.25%.
“Over the past five years the average premium to net asset value (NAV) for the infrastructure sector has risen from an average of about 2% to 15%, having peaked at about 18% a month or so ago,” he says.
Is there anything I need to watch out for?
Infrastructure isn’t cheap and McDermott notes investment trusts are currently trading on double-digit premiums to NAV.
He says: “This isn’t unusual in recent times: this sector tends to trade at a premium (has only been at a discount briefly in the financial crisis). The assets are traded so rarely that it is difficult to value them, so discounted cashflow is used instead. So you are really making a judgement call on the risks of the investments versus what the managers think when they value.”
Sarasin & Partners says infrastructure isn’t uniform in its risk-return profile, spanning the spectrum from lower to higher risk but as with any investment, there will be projects that for one reason or another fail to deliver the expected returns.
It cautions investors to be wary of the stage at which they buy into an infrastructure project. This is because early investment could mean taking on more construction risk which, while likely to lead to higher returns, will increase the riskiness of the project.
Furthermore some funds only purchase assets after the project has been completed. This means that returns are more closely linked to bonds than equities. While there are no construction risks with these assets, there will be some operational risk.
The other thing to watch out for is that cashflows may have a finite time horizon or duration as some investments into mature projects payout all their return over a given time frame. “As the underlying assets are depreciated over the time, there will be no capital left at the end of the period.”
Morgan notes there have been a couple of instances of high-profile issues with projects in the news over the past year highlighting the risks. This includes the closure of seventeen schools in Edinburgh after a wall collapsed at one of them and it was discovered there were faults in construction.
“Construction problems or delays can impact returns, and many projects are subject to government policy which can change,” Morgan says.
How do I access infrastructure investing?
Morgan says you can take an equity participation in the project or company. That way the investor participates in the profits, dividends and growth in asset values, but also has to bear the risks if things go wrong.
“They end up at the back of the queue if the assets are sold off or go into administration, and lose their dividends and even their entire investment if things go really badly,” he says.
Alternatively, you can invest through a bond. While this limits the return, it offers some priority in getting money back if the company or project needs selling off, refinancing or breaking-up.
The other route is going through an investment trust. For the cautious investor, he lists International Public Partnerships, a closed-ended fund invested in over 100 assets including the Thames Tideway project. It has some overseas exposure including in Australia, Canada, Germany and the US which will have a positive impact on income given the fall in the pound though nearly two-thirds of its portfolio is UK-based.
“We regard it as having far better potential to deliver income and capital growth from its assets over time than most of its competitors. Shares trade at an 11% premium to NAV, but this is less than it has been in the past and with a relatively safe yield of around 4%, it is attractive.”
For those with a riskier appetite, he picks Foresight Solar fund which invests in operating UK solar power plants to provide shareholders with a sustainable and increasing income stream.
“I like Foresight’s approach to the solar renewable energy sector in that it only buys assets that are completed and are fully accredited to receive payment under the government’s green benefits regime (i.e. they assume no development or construction risk).”
He adds the trust offers a high starting income of 6% and that payouts could grow given a favourable power market.
McDermott meanwhile likes a couple of open-ended funds. The first of these is Legg Mason RARE Global Infrastructure Income which has a yield of 5%, invests globally and its 13-strong specialist investment team place a heavy emphasis on certainty of future revenues.
The second is VT UK Infrastructure Income, which only launched this year and invests in UK infrastructure only. About two-thirds of the fund invests in investment trusts exposed to different types of infrastructure, while the remainder is held in direct equities. It also holds some infrastructure fixed income and has a yield of 5%.
“If you aren’t so concerned about the yield but like the asset class another fund I like is First State Global Listed Infrastructure. It invests in infrastructure-related shares and was one of the first of its kind.”