HICL Infrastructure (HICL ) is hoping its plan to shun ‘mega’ assets and boost exposure to the ‘modern economy’ will ensure the giant infrastructure fund continues to outperform, after soaring inflation helped it rack up a double-digit annual return.

Annual results for the £3.4bn investment company showed it delivered a 12.8% total shareholder return for the year ended 31 March, with net asset value (NAV) increasing 7.1% over the period. This allowed the company to pay a full-year dividend of 8.25p. That is the highest cash dividend in its listed core infrastructure peer group, but distributions are set to stay at the same level in 2023 and 2024.

Edward Hunt, a director of HICL’s fund manager InfraRed Capital Partners, said higher-than-expected inflation had fed through to asset valuations, and ensured ‘continued market pressure on infrastructure asset pricing’.

This meant the three disposals the listed fund made in the year, including the sale of Queen Alexandra Hospital, which HICL took on after the collapse of Carillion in 2018, had made ‘an outsized contribution to portfolio outperformance’.

‘The results are underpinned by the way we built the HICL portfolio,’ said Hunt. ‘It is deliberately positioned to capture the effect of inflation.’

Hunt noted that the fund benefits from its inflation-linked contracts via its public-private partnerships and regulated assets, and also benefits from inflationary pressure on other assets like toll roads when the prices rise.

The fund is also set for a further potential inflationary boost over coming years. If annual inflation is 3% higher than HICL’s valuation assumptions in the next three years, NAV would increase by 10.2p per share, according to the results. 

With higher inflation, however, typically comes higher interest rates – as is currently being played out in the UK and US. Infrastructure funds have enjoyed a long run of low interest rates, which not only enticed income-seeking investors but also meant the discount rates – which are used to determine the future cashflow and thus value of an asset – were low.

As interest rates rise, so too does the discount rate, reducing an asset’s value.

However, Hunt said this was unlikely to be a problem for the infrastructure fund in the short-term as, while interest rates have been ‘climbing down steadily over the last 10 to 12 years, we have not seen discount rates come down to the same extent.

‘The gap between the discount rate and the risk-free rate has widened over time so there is a bit of a buffer there to higher interest rates. The risk-free rate has gone up over the past year but we are not yet seeing an impact on asset prices, which have actually gone up,’ Hunt said.

Navigating stiff competition 

Asset prices have undoubtedly been kept high by the fierce competition in the sector, which both asset managers and investors have piled into in recent years as low interest rates left them hunting for reliable sources of income.

‘The market is competitive and it has been competitive for a really long time,’ said Hunt. ‘Infrastructure assets are few and far between so when they do come to market, the demand outweighs the supply, and that is especially the case at the moment.’

He added that he is ‘focused on running our own race’, which includes targeting ‘mid-market positions’.

‘There is no lining up for mega-auctions for high-profile assets,’ he said. ‘We also look at buying more of existing positions we have in the portfolio and we have a relationship-driven pipeline where we have an angle with the vendor or know the market well.’

The fund is currently in talks on more than £500m of pipeline investments, which Hunt said covers a ‘good spread of more traditional infrastructure investments like rail and road…and more modern economy sectors’, such as communications and assets linked to the energy transition, but not renewables.

He said there had been an ‘evolution’ in the pipeline towards the ‘modern economy’ which he ‘flagged a couple of years ago’, but at the time it was too risky for the HICL strategy.

‘Now it has matured…and I’m pleased to see more of these assets coming through that are of high quality,’ he said, noting the recent acquisition of a 55% interest in ADTIM SAS, a wholesale fibre network servicing rural communities in France, which now makes up 2% of the portfolio.

Stifel analyst Iain Scouller said while investors are drawn to the inflation-linked nature of the fund’s assets, ‘quite a lot of good news is priced in’ and he feels the shares are ‘at the upper end of their trading range’.

Scouller said: ‘The shares are now trading on a 9% premium to our NAV expectation…which we think is expensive at a time when discount rates in the next six months are likely to be stable, at best…the dividend is flat with no growth forecast by the board in 2023 or 2024…[and] equity issuance is expected at some point given there is a pipeline of potential investments of over £500.’

In the five years to 25 May, HICL’s shareholders have enjoyed a 31% total return versus the 44% average performance in the Association of Investment Companies’ infrastructure sector.