Mark Dampier: Infrastructure fund is on the right road for attractive yield
Saturday 01 September 2012
Infrastructure has been in the news recently. Some economists and politicians believe spending on infrastructure will pull us out of recession. I don't believe that for one moment, but that doesn't mean it shouldn't be considered as an investment. Infrastructure could provide a useful element of diversification to a portfolio, and it is not directly correlated to equity markets.
HICL Infrastructure Company Limited currently has a portfolio comprising 73 infrastructure projects. It is an investment trust, not a unit trust, so the price will be listed under the Investment Companies sector in the financial press.
The company's investments are predominantly UK-based, although there is approximately 10 per cent exposure to the EU (predominantly in Holland, through an investment in the Dutch High Speed Rail Link and Ireland) and 3 per cent invested in Canada.
I recently met Tony Roper, a director of the trust, who explained that infrastructure investments tend to be lumped into one. He sees four distinct parts, ranging from those with low revenue risk to those at the higher end of the risk spectrum. Lower-risk investments include "public assets" such as schools and hospitals. These typically have some form of government backing and revenue streams often rise in line with inflation. Second, there are "regulatory assets" such as those associated with the distribution of energy or water; and "demand-based" assets such as toll roads and airports. These are more sensitive to the economic cycle, as users will tend to cut back during a recession. Finally, there are "private equity" type investments such as ferries, waste management and service stations. These tend to be subject to greater competition, increasing the risks to revenue.
HICL tends to focus on "public assets". As a result the company should offer investors a more stable investment and, importantly, an attractive income. The yield is currently a healthy 5.5 per cent, which I suspect is one reason why the trust is trading on a premium to NAV of almost 9 per cent.
Tony Roper is keen to stress that lower risk does not mean no risk. Key risks associated with infrastructure investment include counterparty risk – a lot of work is subcontracted and there is a chance a subcontractor could go bust. Second, there are maintenance and replacement costs associated with any development. Changes in corporation tax can also be damaging, but fortunately the last move from the Government on this front was to reduce the corporation tax rate. Political risk should also be considered. Legally binding contracts are signed, but politicians have a habit of changing the rules.
Economic drivers also need to be considered, including inflation. Infrastructure projects are long dated (ie, once completed contracts tend to last between 20 and 30 years) and despite many having some inflation protection built in, higher inflation could push bond yields and deposit rates higher, which in turn could make the returns on infrastructure investments look less attractive in comparison. That said I cannot see deposit rates rising for some time, although the jury remains out on bond yields as much depends on the eurozone's travails.
Infrastructure investment requires plenty of expertise and Infrared, the management company behind HICL Infrastructure, has 90 staff. In addition to this trust they look after seven other infrastructure vehicles.
Valuations are done twice a year and the company's fees are tapered, with 1.1 per cent charged on the first £750m of gross assets; 1 per cent between £750m and £1.5bn of gross assets; and 0.9 per cent thereafter. With the trust trading on a premium more shares have been issued to help satisfy demand, and it has grown to over £1bn. This is the second largest trust in the sector and around £2m of shares a day currently change hands, providing reasonable liquidity.
I consider this a conservatively managed investment trust backed by plenty of expertise and with plenty of excellent long-term infrastructure projects behind it. My main caveat is the trust currently trades on a premium. As an investor I always want to buy at a discount. The premium can be justified to some extent by the quality of the underlying management, but premiums also often signal an area in fashion and the trust's large yield is certainly attractive while interest rates remain so low. For investors seeking a stable income in a relatively low volatility investment HICL could be a consideration, but I would rather wait and hope to pounce if it dropped to a discount.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk/independent
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