Is now a good time to invest in infrastructure?

Infrastructure stocks hit a trough in Autumn 2023, but could now be on the road to recovery.

The FTSE Developed Core Infrastructure Net Index is up 18% in the 12 months to 29 January. And while there are headwinds for infrastructure investors on both sides of the pond, the picture, particularly in the UK, could be about to get even stronger.

Investors selecting the top stocks, funds and trusts are often drawn towards high-growth sectors like tech and artificial intelligence (AI). Meanwhile, infrastructure investments can be overlooked.

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The macroeconomic environment hasn’t been supportive of infrastructure stocks of late. “Since their main return comes through a steady cashflow, they are very sensitive to interest rates,” says Ben Seager-Scott, chief investment officer at Forvis Mazars.

With interest rates beginning to come down, though, now could be the time to consider investing in infrastructure. For one thing, there are certain parts of the infrastructure industry that tie in closely with AI, especially around data centres and the power required to run them. Many infrastructure funds have a focus on long-term sustainable goals such as renewable energy, so benefit from governmental drives towards these goals.

But unlike high-tech growth stocks, which are risky and highly susceptible to macroeconomic shifts, infrastructure stocks can offer defensive qualities and a degree of protection against inflation.

Additionally, the UK government is signalling that it will invest in infrastructure more aggressively at a national level, which could provide much-needed tailwinds to the sector. The King’s Speech in July included plans for a Planning and Infrastructure Bill, which will accelerate the delivery of infrastructure projects, as well as housing.

“We have opened up our planning system to build new infrastructure – like onshore wind farms or data centres driving the AI revolution,” chancellor of the exchequer Rachel Reeves said in a speech on 29 January.

“The commitment to significant investment in our country's infrastructure puts construction at the heart of kickstarting economic growth and we look forward to the Government’s 10-year infrastructure strategy,” said Suzannah Nichol, chief executive of Build UK, in response to the speech.

“We’ve seen the new government introduce some interesting targets for 2030,” Phillip Kent, lead adviser of GCP Infrastructure Investments, told the Association of Investment Companies’ Investing in Infrastructure webinar on 28 January. “Remember, that’s just five years away now, so a lot of investment in infrastructure has got to happen and at a rapid pace. 2025 needs to be the year when policy aligns with ambition in both core renewables and new sectors such as those decarbonising heat, agriculture, industry and transport.”

The political will is there, but does that mean now is the right time to invest in infrastructure?

What are the advantages of investing in infrastructure stocks?

Infrastructure companies have several unique characteristics. These are generalisations, since infrastructure is a broad field with various sub-sectors that have their own unique characteristics, but in general infrastructure stocks share certain qualities for investors.

“Infrastructure is an investment category which is frequently perceived by investors as a diversifying asset from other asset classes,” writes Sergiy Lesyk, director, research and analytics at London Stock Exchange Group (LSEG). “It has been known to provide a hedge to long-term liabilities by offering exposure to stable returns and a steady income.”

Listed infrastructure stocks share a lot of these qualities with bonds, and as such, their returns are often correlated with bonds.

“The past two years have been an uncomfortable reminder of listed infrastructure’s high correlation with bonds in an environment of rising interest rates, stubborn inflation and, most recently, wobbles surrounding the long-term sustainability of government debt,” says Rob Morgan, chief investment analyst at Charles Stanley.

One difference between most infrastructure assets and most bonds, though, is that infrastructure companies’ revenue tends to increase in line with inflation. “Lease terms almost always have written in that payments rise with inflation,” says Seager-Scott. “From that perspective, they have some aspects in common with real assets such as property, and can be conceptually thought of as akin to a perpetual inflation-linked bond.”

What is the outlook for infrastructure stocks?

While infrastructure stocks are still relatively undervalued, this could make it an interesting time to invest in them.

“The bear market in bonds has been a perennial black cloud raining down on the sector, but from this juncture there could be significant value on offer,” says Morgan.

Central banks globally are cutting interest rates, which ought to reduce the upward pressure on bond yields.

This environment could be supportive of share price gains in listed infrastructure, and an uplift for the sector as a whole.

“There are now some highly attractive yields on offer in an asset class where payouts can be expected to gently rise rather than remain static as is the case with most bonds,” says Morgan.

The fall in infrastructure share prices as long term interest rate expectations have risen means that their yields “look pretty attractive now”, according to Seager-Scott, though he adds that “the scope for these assets to structurally rally still seems pretty limited”.

However, industry insiders think that the macro backdrop is increasingly favourable for infrastructure stocks and investment trusts. “The biggest challenge for our sector has been the macro environment, and we’re optimistic that it will turn in our favour in 2025,” Kent told the ‘Investing in Infrastructure’ webinar. “We’re expecting more interest rate cuts in the UK, which will make the income characteristics of infrastructure more attractive versus traditional income assets.”

How to invest in infrastructure

The challenge of investing in infrastructure for most investors is that “by their nature, these are very illiquid assets”, says Seager-Scott. “Selling something like a port or a pipe network is a slow and expensive process – meaning true infrastructure investment is best done on a very strategic basis.”

Institutional investors like pension funds can handle this illiquidity, but your stocks and shares ISA might not.

As such, one of the most popular means for individual investors to access the sector is via infrastructure investment trusts. These, says Seager-Scott, “are closed pools of capital that trade on the stock exchange so can provide an apparent level of limited liquidity on a daily basis”, though he cautions that “they are still subject to the usual volatility of listed instruments and the underlying investments remain highly illiquid”.

Infrastructure investment trusts, like many other kinds, are grappling with deep discounts to their net asset value (NAV) at present, and as such many investors are reluctant to sell them and crystallise these capital losses.

“We have seen record discounts open up across the peer group, which in our opinion remain unjustified and driven by external macroeconomic factors,” says Michael Bonte-Friedheim, CEO and founder of NextEnergy Group, which manages NextEnergy Solar Fund (LON:NESF).

Like many other infrastructure investors, though, Bonte-Friedheim is upbeat: "We remain highly optimistic going into 2025 given the multiple tailwinds supporting the global solar market including the UK government's positive position and ambitious goals on renewable deployment.”