Enthusiasm for the renewable energy sector has cast a shadow over the original infrastructure funds with a much broader remit. These diversified funds continue to prosper, delivering rising dividends and asset values from investment in cyclical businesses and facilities. These have little, if any, revenue risk, strong cash flows, inflation protection and, hopefully, the potential to add modestly to returns through active management.
The original three – HICL Infrastructure (LSE: HICL), 3i Infrastructure (LSE: 3IN) and International Public Partnerships (LSE: INPP) – were floated in 2006-2007. They were joined by GCP Infrastructure Investments (LSE: GCP) in 2010, BBGI Global Infrastructure (LSE: BBGI) in 2011 and Pantheon Infrastructure (LSE: PINT) last year. The first four have grown significantly through share issues to finance acquisitions and now have assets of £3bn, £2.5bn,£2.8bn and £1bn, while the fifth is now 64% invested and has assets of £400m.
Reflecting its higher historical returns (which come with higher economic risk), 3IN yields 3% and trades on a 22% premium to net asset value (NAV), while the numbers for HICL are 4.2% and 15%, for INPP 4.5% and 12%, for BBGI 4.2% and 20%, and for GCP 6.2% and 0%. PINT trades on a 9% premium but has yet to pay a dividend. These premiums reflect the conservative valuation of the underlying assets but also enable the funds to issue new equity at a premium to book value (though not necessarily to the true value of their assets).
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While dividend growth has been steady, NAV and share-price performance has varied widely, reflected in a share price of 350p for 3IN, 177p for HICL, 166p for INPP, 177p for BBGI and 113p for GCP, at the time of writing. Since all initial public offerings were priced at £1, this implies that 3IN has had the highest returns, followed by BBGI and then HICL, INPP and GCP.
Debt and equity
The funds have their differences. The capital structure of a typical investment is a mixture of equity, debt and secured bank loans. While most of the infrastructure funds invest in the equity portion, GCP focuses its investment in the debt. This should be lower risk than the equity – although, should a project get into financial difficulty, in practice the banks will seize control to cover their loans. The owners of debt have precedence over the equity, but they often sink together.
The owners of the equity portion, however, have the benefit of additional returns from good management and can exercise control to improve performance if things aren’t going well. Since few projects have got into trouble, the drawbacks of the GCP strategy have outweighed the benefits, leading it to seek inflation linkage (now 52% of its portfolio ) and moderate upside exposure. By sector, 62% of the portfolio is invested in renewable energy, 23% in public-private partnership (PPP) projects and 14% in supported living (ie, housing).
At this point, a yield over 6% and shares trading at asset value are undeniably attractive, both in absolute terms and relative to fixed interest alternatives – especially as GCP has, unlike a typical bond, been able to increase both its net asset value and dividend over the years. Hence the shares are a buy, says analyst Iain Scouller at investment bank Stifel.
HICL focuses on “core” infrastructure – ie, “essential real assets that deliver resilient cashflows from a protected market position”. Though it has diversified from its original remit of UK PPP projects into investing overseas and other areas (such as water), it is more averse to revenue risk than the others. Just 22% of the portfolio is in demand-based assets such as roads and rail (including 5% in the HS1 rail project).
Regulated assets account for 12% – primarily Affinity Water, which supplies water but not waste water services in the home counties. Regulation is increasingly fierce, but Affinity has kept in the regulator’s good books through investment and good service. That leaves 66% of the portfolio in PPP projects such as hospitals, schools and government buildings in the UK and overseas. Europe is now 18% of assets, with 9% in North America.
The appeal of PPP
Under PPP, the private sector finances and builds projects for the public sector, then manages them for a fixed number of years before ownership reverts to the public sector. The infrastructure companies buy the completed project from the contractors using a mixture of equity, bonds and bank loans, sub-contract the management while maintaining overall control and responsibility.
Since revenues are inflation linked, this provides HICL and other operators with a predictable long-term income stream with the opportunity to add value from cost savings, improvements and investment. The result is moderate, predictable and low-risk returns. Since flotation, HICL has delivered a total shareholder return of 9% per annum and grown its dividend by 35%, helped by asset sales at premium prices, new investment and a consistent record of adding value.
Against this, “a lot of good news is priced in”, says Scouller. The shares are trading at a high premium and “equity issuance likely at some point”.
BBGI invests exclusively in PPP (“availability-based investments”) but 67% of the portfolio is overseas, notably in Canada (36%), Australia, (11%) Europe (9%) and the US (11%). This makes it a beneficiary of weaker sterling, reduces the political risk and increases the investment opportunities. Transport accounts for more than half the portfolio but these are not toll roads so there is no revenue risk. Unlike the other funds, it is self-managed so ongoing charges are well below 1%.
These strengths, a good record of adding value from asset management (1.4% last financial year) and a consequent annualised shareholder return of 10.4% are reflected in BBGI’s premium rating.
The annualised shareholder return for International Public Partnerships since flotation is only 8.5%, held back in part by ongoing charges of 1.18%. It recently raised £325m of new equity, so there is no chance of further new issuance to depress the price. With trading reported to be strong, the Thames Tideway “super sewer” project progressing well (9% of the portfolio), and inflation assumptions of just 2.75% for this year and next, a good uplift in net asset value is likely.
INPP is regarded as having one of the most diversified portfolios, though 75% is in the UK. Pure PPP with no revenue risk accounts for 31%, PPP with some revenue risk 10%, regulated assets 47%, railway rolling stock 10% and digital infrastructure 2%. Assets include electricity transmission, gas distribution, waste water, military housing and schools. The discount rate – the implied future return on investment – is 7% but INPP has a good record of adding value, making long-term shareholder returns sustainable.
Taking on more revenue risk
3i Infrastructure – which is 30% owned by private-equity firm 3i – takes on more revenue risk than the others with low exposure to PPP. Economic infrastructure accounts for more than 60% of the portfolio while “core” (regulated) infrastructure is about 25% and PPP not much over 10%. This results in a target total return of 8%-10% per annum though, in practice, 3IN has achieved more than 13% annualised since flotation.
There is far less explicit inflation linkage than in the other funds but “real assets like infrastructure which provide essential services have real pricing power, making them very attractive in the current environment”, notes Chris Brown at investment bank JP Morgan Cazenove. Some 44% of the portfolio is described as focused on “energy transition”, 25% on “digitalisation” and 16% on “globalisation”. Just 36% is in the UK.
The largest investment, accounting for 17% of the portfolio, is ESVAGT, which owns and operates support vessels for offshore wind farms and emergency response, while 10% is in Infinis, a UK-based generator of renewable power, 9% in GCX, which owns 66,000km of sub-sea cables and 9% in TCR, which operates ground-support equipment for airports.
3IN is happy to realise profits on successful investments and reinvest the proceeds. Last year it sold a good part of Oystercatcher, its oil-bunkering business, as well as several European PPP projects, and invested in GCX and more recently, doubled its stake in TCR to 96%. It can be regarded as operating halfway between lower-risk infrastructure funds and higher-risk private equity funds, although its yield – paid from operating income – has kept the rating of the shares near the former rather than the latter.
The latest arrival
Rather than compete with the established funds, Pantheon Infrastructure has focused on communications and data centres but there are also investments in renewable energy and power transmission and distribution. Its focus is on co-investment, rather than control, and its target investment return of 8%-10% suggests a risk profile closer to 3IN than the others. It’s early days but the reputation of investment manager Pantheon, the investments made so far and the record to date suggest that this, too, is a fund worth backing.
All the funds have performed well in difficult markets and can be expected to ride out economic turbulence. TCR may have been hit by the shut-down of airports but the effect on 3IN was minor and other investments benefited from lockdowns. Relationships with regulators have been well managed and political threats, such as windfall taxes, have diminished.
With revenues either explicitly or implicitly linked to inflation, and the funds, especially those with PPP, often benefiting from higher interest rates, they are all well placed in current market conditions. The only caveat is that rising bond yields undermine the relative attractiveness of their yields. While real yields are strongly negative, the inflation protection more than compensates. However, when real bond yields turn positive again – which does not look imminent – the sector will be rowing against the current.
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+.
Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts; two directorships are still active.
After 39 years in financial services – including 30 as a professional fund manager – Max took semi-retirement in 2017.
Max has been a MoneyWeek columnist since 2016 writing about investment funds in magazine and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications.
See here for details of current investments held by Max.
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