Jeremy Warner's Outlook: Suddenly infrastructure investment is all the rage: valuations are climbing to compensate

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The Independent Online

The idea of infrastructure as the new dot.com would once have been thought laughable, yet all of a sudden toll roads, airports, water companies and even half-built rail links are the hottest investment properties in town. To add to Ferrovial's planned consortium bid for BAA, owner of a clutch of the nation's most important airports, there's now the possibility of a Goldman Sachs-led bid for London & Continental Railways, the company behind the yet-to-be-completed high speed, Channel Tunnel rail link and the co-owner of Eurostar.

Mirroring this upsurge of interest in what used to be thought of as dull, old utilities there is a sudden spawning of infrastructure funds. The phenomenon cannot yet be compared to hedge funds or private equity, either in size or number of players, but already infrastructure is taking on the attributes of a distinct asset class. Over the past year, the success of the original Macquarie European Infrastructure Fund has given rise to a plethora of copycat versions, from Goldman Sachs and ABN Amro, to JP Morgan and many others besides.

Why all the excitement? What these funds attempt to do is cater for a demand among pension funds, with their exceptionally long-term liabilities, for matching assets. To date, this has tended to be satisfied simply by buying bonds, a demand that has driven yields to unsustainably low levels.

Though plainly not quite as safe as gilts, which are guaranteed by the taxpayer, many infrastructure projects may have some of the same attributes - predictability of cash flow, protection against the vagaries of the economic cycle, and in most cases, exceptionally long life expectancy. Many of them even provide a hedge against inflation through their regulated charging structures. Just what the pension fund doctor ordered.

One of the curiosities of the present craze for such assets is that many of them have been there all along, but until now have remained largely unloved and unrecognised.

It's been possible to buy shares in BAA since the late 1980s, yet it is only lately that the true value of this business as a dependable, inflation-proofed source of long-term income, with quite considerable growth potential to boot, has become appreciated. Why invest in the infrastructure fund when you can buy the shares directly? It's an interesting question which as ever, pension-fund trustees struggle to answer.

As the attractiveness of these assets grow, so of course does their value. For the time being, the promoters of these infrastructure funds regard their multiplication as more of boon than a threat, for it improves the credibility of the asset class and helps them draw in more money.

Yet already the competition for smaller infrastructure assets is leading to some alarmingly high valuations. That's not yet apparent in larger projects, where many funds prefer to partner with each other than risk the possibility of an auction. The ever rising BAA and London Stock Exchange share prices none the less demonstrate that the easy pickings in this market may already have gone.

As for the proposed bid for the Channel Tunnel rail link, this makes for an odd hybrid around the idea of the risk-free infrastructure project. Like that of the Channel Tunnel itself, the history of this troubled railway project shows it to be far from risk free.

The whole thing has had to be bailed out not just once, but twice by the Government, and heroically optimistic assumptions about likely traffic levels have had to be slashed. There is an argument for buying an infrastructure asset before the actual level of demand for it is known. With luck it will surprise on the upside. Yet experience with the Channel Tunnel shows it's just as likely to disappoint, negating the predictable returns investors are looking for.

The involvement of Sir Adrian Montague, a merchant banker turned Treasury adviser and transport guru, makes the process of selling London & Continental that much more problematic. If the Government and its partners sell to the Montague consortium, they lay themselves open to the charge of cronyism.

As the search for suitable infrastructure investment grows, the targets chosen necessarily become bigger, more ambitious and more high risk. The emergence of consortium bidders, in order to achieve the necessary critical mass, makes the process more complex still. Consortium bids are notoriously difficult to manage and invariably fall apart at the first hint of controversy.

Still, for the time being, it's open season.

Predictable nirvana in Inflation Report

Most chief executives aim to quit while still ahead and certainly well before being overtaken by some ghastly crisis in the company's affairs. This is all too often the fate of even the most accomplished chief executives if they hang around for too long.

On this rule of thumb, Mervyn King, Governor of the Bank of England, should perhaps already be preparing for his own departure, for judging by the latest Inflation Report, he's achieved a state of such near perfection that there's nothing left to be done. If it can't get better, it can only get worse.

With the Bank's latest forecasts showing inflation virtually spot on target until the end of the decade, on the central projection at least, Mr King seems finally to have succeeded in his ambition of making monetary policy boring. For a central banker, this is as good as it gets - a veritable nirvana of stability. Even the GDP forecasts make for pleasing reading, with the rate of growth recovering to around trend by the end of the year and then broadly staying there until the end of the decade.

Not that Mr King sees it in quite that way, of course. Instead, he sees risks on all sides and, with characteristic candour, rates the chances of the economy performing exactly as forecast as negligible.

Yet perhaps the most important message to be taken from yesterday's Inflation Report and the Governor's accompanying remarks is that interest rates are not about to come down again any time soon. The trouble with predictions is that events have a nasty habit of intervening. Yet, on the basis of what we know, it seems that the Bank of England's interest rate at 4.5 per cent may have reached its natural level from which it won't need to diverge, certainly for months, and quite possibly for at least another year.

There are plenty of people who would disagree with this proposition, not least my colleague Hamish McRae, who believes the Bank is underestimating the chances of a sharp slowdown in the economy.

There are even some who believe that with the continued strength in energy prices, the next movement in rates may even be up. Yet whichever way they move, it's unlikely to be beyond the parameters established in the last two years of between 4 and 4.75 per cent. Compared with past experience, these are differences so small as to be virtually insignificant.

Nor, thankfully, does Mr King consider interest rates of any use as a tool for rebalancing the economy so as to make growth more dependent on investment and exports, and less so on consumption.

The Governor's view is that rates should not impede such a rebalancing, but nor should they be used deliberately to encourage it. It's not hard to see why. Put them up to discourage consumer demand, and you will succeed only in further undermining exports and investment. Put them down to encourage exports and investment, and you only encourage further consumption.

In other words, rates are not to be used to address the structural imbalances in our economy. That's for the Chancellor to address through fiscal policy, though there's little evidence of willingness to do so.

How nice it must be for the Governor to have achieved such a heightened state of boring predictability. Or perhaps beneath the calm exterior, he even longs for his mettle to be tested by crisis.

j.warner@independent.co.uk

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