Less than a week after David Cameron announced the Government's savage budget cuts, the Prime Minister unveiled a £200bn national infrastructure plan, making the sector an "ideal opportunity" for investors seeking steady returns, according to one investment manager.
British outsourcing companies, such as Carillion, should also do well as the Coalition looks for cost-effective ways to delivery essential public services amid sweeping spending cuts.
Outsourcing will be key for UK equity growth, according to Neil Tong, manager of the Alliance Trust Asset Management UK Equity Income fund. "Many areas of outsourcing have the potential to increase revenue at above the rate of gross domestic product growth," he says.
We ask the experts about the sectors that will benefit and what they are buying – both at home and overseas.
Schools and hospitals
Government departments will have to cope with average cuts of 19 per cent over the next four years. However, the Chancellor, George Osborne, has promised a real increase in money to schools and the healthcare sector. The NHS will see its budget increase from £104bn today to £114bn by 2014.
Simon James, founding partner of Gore Browne Investment Management, says stocks that tap into social infrastructure projects offer "an ideal opportunity for investors looking for secure returns in the current economic climate". "Providing good yields with a strong inflation link and predictable returns, social infrastructure investments are asset-intensive businesses, which provide essential services to society – schools, hospitals and prisons," he says. "Revenues are not based on usage but provision, so they offer a secure investment with contracts backed by the government."
Two investment trusts called International Public Partnerships (IPP) and 3i Infrastructure are "interesting propositions", he says, because they invest in a range of public-sector projects. The 3i fund, for example, has £37m in a portfolio of 16 UK-based education and healthcare private finance initiative (PFI) projects, £29m in a 35-year PFI contract to build, operate and maintain a hospital in Norfolk, and £16m in a 30-year contract to build, operate and maintain 11 new schools in Scotland.
The trust is up 17.7 per cent over a year and 28 per cent over three years, according to data from Trustnet. IPP, meanwhile, has made 4.6 per cent over the past year and 26 per cent over three years. Mr Tong likes Serco, the support services giant that works for national and local government on health, education, transport, science and defence projects. Its shares have risen by almost 5 per cent in the past year.
The Government's plan calls for a commitment of £30bn for transport, including a high-speed rail network and investment in roads. Keith Bowman, an equity analyst at Hargreaves Lansdown Stockbrokers, tips high-speed rail as the next big investment theme, amid changing travel habits.
"The Icelandic volcanic ash episode back in April underlined the potential fragilities of air travel, while ongoing security issues are, knowingly or not, wearing down the propensity of individuals to fly," he says. "Improvements in high-speed rail travel and journey times have made rail an increasingly attractive alternative to short-haul air travel."
He likes Costain Group, the UK-listed construction and engineering company, which helped to build the Channel Tunnel and the rail link between St Pancras station in London and the Channel Tunnel itself. Its latest interim results saw it post a 19 per cent rise in pre-tax profits to £8.2m. Its shares have a historical dividend yield of 3.7 per cent. "Having suffered financially in the early millennium, Costain has undergone a successful transformation over recent years," says Bowman. "The dividend is proving increasingly attractive."
Eversholt Rail Group has also proved an attractive proposition of late, with HSBC agreeing to sell it earlier this month to a consortium of investment funds managed by 3i Infrastructure, Morgan Stanley Infrastructure Partners and STAR Capital Partners, for £2.1bn. One of three leading rail rolling stock companies, Eversholt owns 29 per cent of the British rail fleet.
The construction services group Carillion is a favourite of Mr Tong and Mr Bowman. The company said in August that it was well placed to support the Coalition's efficiency drive as it unveiled a 17 per cent rise in profits. Its shares are up almost 12 per cent in the past year. Darius McDermott, managing director of the discount broker Chelsea Financial Services, advocates a "less risky and more managed approach" – buying an investment fund with a pool of assets, including those involved in construction.
The Rathbone Income fund, managed by Carl Stick, holds Carillion, the structural steelwork fabricator Severfield-Rowen and the engineering specialist Keller. Gore Browne Investment Management believes construction, in general, remains undervalued. Investors should back well-financed businesses with strong balance sheets. Its pick is Kier Group, whose shares have rallied almost 22 per cent in the past year. Mr James says: "Looking horizontally within the same sector, property could be another unloved sector that could experience a boost following the spending review.
"With house and commercial property prices down, a lack of financing from banks and the spending cuts, this could be an area the Government will need to help to relieve pressure on consumers, who will become increasingly worried about rising unemployment and falling house prices."
He tips the house-builder Persimmon and commercial property firm Land Securities.
Gold in emerging economies
The infrastructure theme is one that investors can tap into around the world: China, India and Latin America need to spend vast sums on infrastructure to keep pace with their rapid urbanisation and economic growth. Latin America has among the highest levels of infrastructure investments worldwide, with over $450bn (£281bn) of projects planned until 2015, according to BNY Mellon, which last month launched a Latin America infrastructure fund. Brazil is leading the way with 150 infrastructure projects with private participation worth over $229bn.
Jose Tovar, the managing director at BNY Mellon ARX Investimentos in Rio de Janeiro, says: "We are living through an exciting investment era in Latin America. Now, more than ever before, there are better incentives for private infrastructures participation. The current economic momentum is likely to result in a prolonged period of growth."
The picture is the same in other emerging economies. Within the next two decades, more than 60 per cent of the global population is expected to live in cities, and increased urbanisation in emerging markets requires significant investment in core infrastructure, says Fidelity Investment Managers.
Up to 170 Chinese cities could require mass-transit systems by 2025, which could create one of the greatest ever booms in construction of such networks. Outside of the cities, a massive rail network is being built to connect the cities to rural areas. China Railways has been adding track to the network at about 1,000 kilometres a year, a figure expected to rise to 10,000km per year by 2012. To put that into context, the entire German rail network is the longest in Europe, at just 34,000 kilometres. Bowman, at Hargreaves Lansdown Stockbrokers, likes UK-listed Invensys, which continues to expand its railway operations into emerging markets, particularly China.
Meanwhile, an estimated $500bn must be spent to bring India's infrastructure up to standard. Transport and power are expected to attract 60 per cent of that money. 3i Infrastructure – the "preferred infrastructure play" of broker Killik & Co – had £105m in 3i India Infrastructure, a fund investing in building projects in India, as of 30 September, and has since boosted that by £15m.
The British Government's plans include a Green Investment Bank to provide up to £1bn towards carbon capture and storage demonstration projects on a commercial scale. Despite the sum being half what was hoped for, a further £2.9bn was committed to climate change finance in the Comprehensive Spending Review.
Mr James at Gore Browne says the Coalition might look to firms such as Centrica to help build new energy plants, while Rupert Robinson, the chief executive of Schroders Private Bank, likes energy stocks in general. "Now that the second round of quantitative easing is behind us, investors' focus will shift from liquidity to growth prospects – energy, and oil in particular, will benefit," he says. "We are moving money into energy stocks for our clients. The energy sector has lagged other commodity stocks, and valuations look attractive, particularly mid-cap oil services and exploration and production companies."
Mr McDermott likes the First State Global Listed Infrastructure fund, which holds utilities such as gas, electricity and water companies, as well as those running roads, railways and airports. It has 40 per cent exposure to the US, 39 per cent to Europe and 9 per cent to Britain – so taps into US President Barack Obama's drive to improve American infrastructure.
"It is a single-sector fund which is high risk, but because its investment remit encompasses a wide range of sub-sectors across several industries the risk is diluted," adds Mr McDermott. The fund has returned 14.2 per cent over a year and 9.9 per cent in the part three years, Trustnet data shows, and yields 3.1 per cent.
Its top ten holdings include Koninklijke Vopak of the Netherlands, which builds and runs chemical and oil tanker terminals, Florida Power & Light Company, PPL Corporation, which has 12,000 megawatts of power capacity in the US, Britain's National Grid and the German utility E.on.Reuse content