The gold price is up, bond yields are down, and investors are asking themselves which asset classes can shield their wealth until the impact of Brexit becomes clearer. But amid the political and economic uncertainty, two facts are unlikely to change.
First, the UK population is growing, and may reach 70m people by 2027 if an estimate by the Office for National Statistics is borne out. The second is that the UK’s infrastructure will need to be upgraded as greater demands are placed upon it. “The formation of the National Infrastructure Commission and the undertaking of the National Needs Assessment shows how the UK is coming up with a long-term strategy for its infrastructure,” says Richard Laudy, head of infrastructure at Pinsent Masons.
This presents an opportunity for investors.
Notwithstanding schools, hospitals and other social infrastructure projects, the UK currently has more than 600 others in the pipeline with a combined value of £375bn. As the government continues to battle the fiscal deficit, it has become more difficult to finance these projects off its own balance sheet.
And if Brexit causes the UK economy to soften, the government may become even more reliant on the private sector to provide the capital to build and manage these projects.
Projects are typically financed with 90 per cent debt and 10 per cent equity. Retail investors can access the sector through infrastructure investment trusts, exchange-traded and passive funds, or shares in companies like the FTSE 100-listed 3iInfrastructure, which makes equity investments in entities which own infrastructure businesses and assets themselves.
Infrastructure funds are currently trading at a premium to net asset value, which means that investors are paying more than the value of the fund’s underlying assets. But infrastructure investment comes with numerous benefits.
First, projects are backed directly or indirectly by the government, which is unlikely to default on its obligations. Second, contracts often last decades, providing long periods of stable returns. Payments for managing a project tend to rise with inflation, so shareholders enjoy inflation-linked returns and steady cash flow. 3i Infrastructure, for example, is committed to progressive dividend increases, and aims to increase its dividend payment by 4 per cent this year.
Infrastructure funds are currently trading at a premium to net asset value, which means that investors are paying more than the value of the fund’s underlying assets
“Infrastructure is characterised by strong, sustainable yields. This is why it is popular with pension funds and insurance companies which rely on a consistent income to fund their liabilities,” explains Giles Frost, chief executive of Amber Infrastructure Group. His firm’s International Public Partnership fund is a leading investor in the Thames Tideway Tunnel, a super sewer which is one of the biggest projects in the capital, and recently increased its stake in the Wolverhampton Building Schools for the Future project to 82 per cent.
“Infrastructure is decorrelated from other asset classes like real estate and equities,” says Frost, insulating it from current market turmoil.
Toll roads or hospitals?
The returns from assets which aren’t dependent on demand – such as schools, hospitals and other social infrastructure – will be more stable than those which are. This is because the government will pay developers even if demand falls away.
“Demand assets tend to have a strong link to GDP,” explains Frost. “The performance of toll roads and ports, for example, peaks in boom times and dips during recessions.”
The risk attached to a project is highest in its early stages. Investing before or during the construction phase can be a headache because of the potential for cost over-runs and regulatory obstacles.
The FTSE 250-listed John Laing Infrastructure fund chooses to limit assets in the construction phase to 30 per cent or less of its portfolio, opting instead to run and maintain schools, hospitals and other projects once they have been built, in exchange for government-backed payments which provide shareholders with inflation-linked cash returns.
Electricity transmission and water projects are also attractive. This is because the prices of these utilities are closely regulated. “There is a difference between the regulated return for investors in infrastructure from effective monopolies like National Grid and Thames Water, over government directed projects which take a long time to reach fruition,” says Dan Lewis, senior adviser on infrastructure policy at the Institute of Directors.
As infrastructure contracts last for decades, it is important to consider the creditworthiness of the government backing them.
Infrastructure is decorrelated from other asset classes like real estate and equities
There is also a degree of political risk. In 2013, the Spanish government published a photovoltaic decree which retroactively reduced feed-in tariffs for plants installed between 2009 and 2011, and it was the developers who were left out of pocket.
Investors should be mindful that governments may renege on subsidy pledges depending on the fiscal climate, particularly if those commitments were made when a different party was in government. “Under any chancellor but George Osborne, Crossrail might have been cancelled,” says Lewis.
If UK infrastructure is already proving popular, the sector may attract even more investment from overseas over the next 12 months, particularly from China, thinks Laudy.
A 2014 report by Pinsent Masons and the Centre for Economic and Business Research puts total Chinese investment in UK infrastructure at £105bn by 2025, with energy, real estate and transport being the chief beneficiaries.
“The Chinese have been investing mostly in commercial real estate projects, but not large economic infrastructure,” he says. “We could now see that change.”
Tempted by the prospect of higher returns, these Asian investors may also start to invest earlier, particularly during the construction phase. “They are prepared to take a long-term view, and they won’t be put off by Brexit, which they see as a short-term play.”