Infrastructure trusts may benefit from lower rates
A rate cut is very likely at the Bank of England’s meeting this month, writes David Prosser.
The Bank of England’s Monetary Policy Committee is apparently split on interest rates. While some members are in favour of lowering rates at August’s meeting of the MPC, pointing to the need to support the faltering economy, others see persistently above-target inflation as a reason to wait. Still, most economists are expecting a small cut to rates at the August meeting, followed by further reductions over the months ahead.
That’s potentially good news for the investment trust sector, which staged something of a fightback during the first half of the year following a challenging 2024. One of the major headwinds holding back the sector in recent times has been higher rates, which are generally perceived as a negative for stock market assets, including funds quoted on the stock market such as investment trusts.
Falling interest rates are good news for investors in infrastructure.
David Prosser
Ironically, however, the biggest investment trust beneficiaries of interest rate reductions are likely to be found beyond traditional equity investments, with trusts that have exposure to infrastructure set to outperform as rates come down.
Indeed, there is a direct link between interest rates and the value of infrastructure assets. Analysts value these assets using a technique known as “cash flow discounting”. In simple terms, they look at the cash flows that infrastructure is set to generate over many years into the future; then they discount the value of those cash flows using prevailing interest rates to come up with a present value. The lower the interest rates, the higher the present value of those future cash flows (in other words, the more you’d need to pay now to secure those cash flows in the future). And when interest rates fall, that automatically means higher valuations for infrastructure assets.
In practice, such logic rarely translates perfectly into what actually happens in the market. Interest rate changes, after all, don’t happen in isolation; there are always many other things going on with the potential to affect valuations. Still, all other things being equal, falling interest rates are good news for investors in infrastructure.
It’s worth pointing out too that the demand for infrastructure – in the UK and worldwide – is larger than ever. Witness the recent announcement of a £49 billion project to expand Heathrow Airport, for example. Consider the giant technology company Meta’s results, which included plans to spend tens of billions of dollars on IT infrastructure worldwide, from data centres to power generation facilities. And don’t forget the fast-growing renewable energy sector, where solar, wind and tidal facilities must be installed at pace if we are to have any hope of mitigating climate change. The list goes on and on.
All of which provides a compelling case for building long-term exposure to infrastructure assets into your portfolio. And the reality is that the investment trust sector is the easiest way to do that. It gives you access to a highly illiquid asset class – airports and power stations, say, are hugely costly assets that are very hard to buy and sell – through a liquid investment structure, where you can trade in and out of funds at will on the stock market. The Association of Investment Companies produced this press release about trusts that could benefit from rate cuts in May, when the Bank of England cut the base rate by 0.25%. There are some ideas there which may provide food for thought.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
