This article on infrastructure funds investing has been published on The Times on the 11th of August 2018.
You would have made a tidy profit if you had followed the advice of one expert in Times Money in April to invest in the John Laing Infrastructure fund. Last month a private consortium offered investors more than 20 per cent above the value of their shares in a bid for the fund and insiders say the purchase is a done deal.
The bid has given UK infrastructure funds a boost, but big price falls before the John Laing offer probably left investors gasping to sell.
In September the Labour Party said that if it won an election it would nationalise private finance initiatives (PFIs), the main source of investments for most UK infrastructure funds. This sent fund values into freefall; in January, the collapse of Carillion, a huge infrastructure project operator, sent investors running again.
A sector that has always been stable and boring, but served as a reliable income generator, seemingly immune from the economic cycle and inflation, is now a political hot potato and one of the country’s most talked about investment prospects. So is now the time to get in, get out, or watch from the sidelines? We consider the options.
Why does the John Laing fund offer matter?
July’s offer by a consortium of private buyers (which shareholders are likely to accept, according to Charles Cade, the head of investment companies research at Numis Securities, a stockbroker) lifted the prices of the sector’s other listed funds.
Rob Morgan of Charles Stanley, an investment manager, says: “The bid demonstrates the level of institutional demand for infrastructure fund assets, a function of reliable long-term incomes rising with inflation.”
He says that these features make the sector appealing to retail investors. The John Laing Infrastructure fund is paying a 4.9 per cent dividend and HICL Infrastructure, another popular UK investment trust, is paying 5.1 per cent.
Will there be more takeovers?
Mr Cade thinks that recent price gains are enough to discourage any more consolidation for the time being. He gives the example of HICL, which has gone from trading at a 5 per cent discount to its net asset value (NAV) before the JLIF offer, to a 6 per cent premium today. “A bid that would have looked appealing in July will now be much less appealing to HICL shareholders,” he says.
The show of intent from institutional investors, however, provides support to fund share prices in the mid-term. If prices fall, investors are likely to launch more bids, pushing prices back up.
Ben Gutteridge, an analyst at Brewin Dolphin, a wealth manager, agrees that although the sector was an attractive prospect in the spring, recent price rises have reduced investor opportunities. “A lot of the infrastructure funds look less good value since the JLIF bid, and there is some political risk. We are cautious on the sector now.”
Why were infrastructure fund prices depressed?
The main problem was political. At the Labour Party conference in September 2017 the shadow chancellor, John McDonnell, pledged to nationalise PFIs, from which the main UK infrastructure funds derive most of their income. This would be part of Labour’s wider aim of reducing private sector involvement in public services.
While fund managers said that the government was legally obliged to continue existing contracts and nationalisation would be possible only at realistic prices, investors were rattled.
The John Laing fund, which has one of the highest levels of PFI exposure in the sector, said that if Labour brought PFI contracts under government control, the fund would get only 86 per cent of the present value of its UK portfolio.
The collapse of the construction giant Carillion in January provided a further setback, although the exposure to contracting companies was relatively low because most of the income was publicly backed. Projects that were managed by Carillion have been passed to other contractors without too much disruption, says Mr Cade.
While Carillion’s collapse was an extreme example, Mr Morgan warns that many other UK contracting companies are in similar positions, “walking something of a tightrope, operating on very low margins”.
What does the recent interest rate rise mean for infrastructure funds?
“As with all income-generating assets, gradual interest rate rises will put pressure on high-quality UK government-backed infrastructure funds,” says Mr Gutteridge.
However, UK interest rate increases are likely to be very slow and Mark Carney, the governor of the Bank of England, has said they would be reversed in the event of a no-deal Brexit. The bigger risk remains political: Mr Cade suggests that prices will fluctuate in line with the odds of a Labour election victory.
What does the future hold?
The sector has always been known for its stable income prospects. Long-term contracts to build and operate schools or hospitals, for example, are linked to the inflation rate, and these benefits broadly remain, says Mr Morgan.
“Usually you have to take much more risk to get this type of income. The government backing provides a reliable and predictable income compared to more variable options such as shares.”
What about beyond the UK?
McKinsey & Company, a consultant, estimates that $57 trillion (£45 trillion) of global infrastructure investment is required by 2030. In the US, president Trump has mooted plans to stimulate $1.5 trillion of infrastructure spending, although no bills will hit Congress before 2019.
“China has shown that it wants to move away from more polluting infrastructure, as witnessed by the shift from coal to gas, meaning there will be many more opportunities in the sector,” Mr Gutteridge says.
Government policy in emerging markets is harder to predict, Mr Morgan says. “You are looking for a stable political regime, with a good solid likelihood for continuation of legal framework”.
Infrastructure investment trusts such as John Laing and HICL allocate very little to the US and emerging markets. Better access to these regions is through unit trusts, which can buy listed companies connected to infrastructure, such as utilities or construction companies.
EXPERTS’ UK PICKS
Rob Morgan of Charles Stanley, an investment manager, suggests the HICL Infrastructure investment trust, which is 78 per cent invested in UK assets, or International Public Partnerships at 71 per cent. Ben Gutteridge from Brewin Dolphin, a wealth manager, recommends the First State Global Listed Infrastructure fund, half of which is invested in the US and 6 per cent in China. “This should prove helpful if the Trump administration can secure a large infrastructure spending bill.”