Big 12: HICL highlights two catalysts to turbocharge gains

Following a tough five years for HICL Infrastructure (HICL ), its manager Ed Hunt highlights two initiatives that he expects will power the trust’s returns and turbocharge inflows into the trust. 

HICL, like other investment companies, has been plagued by a persistent discount over the past few years. Hunt, who is InfraRed’s head of core infrastructure, believes this is much more to do with capital flows rather than fundamentals, given infrastructure funds have low amounts of debt, and offer investors inflation-linked contracted revenues and uncorrelated returns.

However, until investors value these attributes and flock back to the sector, the manager is banking on two initiatives to power returns.

The first is the revival of public-private partnership (PPP) contracts, which will see the government pay private companies to build, maintain and operate public assets.

PPP contracts faced a public backlash in 2018 after Jeremy Corbyn took the helm of the Labour party and threatened to revoke the contracts. However, the current Labour party is taking a more measured approach to the dilemma of a lack of public funding to support much-needed upgrades to public services.

‘We have a lot of infrastructure that is in a state of gradual decay,’ said Hunt. ‘The general public see that and there is clearly a need for greater funding for infrastructure in the UK.’

At the beginning of June, the government confirmed it would use PPPs to fund projects. In Hunt’s opinion, this means the sector is ‘on the cusp of a very large period of investment’.

‘HICL is one of the largest PPP owners in the market,’ he said. ‘The opportunity is exciting.’

However, he said new contracts will be written for the very long term and in the spirit of partnership with the government to avoid the same fallout as before.

‘There is an opportunity to build on the shortcomings of the previous model,’ he said.

‘We have been large investors since the late nineties in PPP and we enjoy excellent relationships with our clients… The majority [of our investments] have been a success and we make sure our contracts are fair and balanced.’

As HICL invests globally, he said the team will compare the PPP offers from the UK versus those offered by governments in other regions.

Index inclusion

Elsewhere, Hunt is working with peers to lobby for infrastructure investment companies to be included in global infrastructure indices.

Historically, investment companies would have just invested in listed equities, which is why index providers typically exclude them to prevent the double counting of equities.

‘Now the sector has moved on and alternatives investment companies make up a large part of the market, holding large portfolios of private assets – so no double counting,’ he said.

‘We would also argue that infrastructure investment companies offer the most pure exposure to infrastructure assets versus, say, an infrastructure operator, which do typically get included in the infrastructure indices.’

Hunt said the talks so far have been ‘constructive’ but they need support from the buy side too,  potentially unlocking a ‘source of new flows’ which could leading to a rerating not just for HICL but the sector at large.

Size doesn’t matter

Hunt is also quick to play down the size of his trust, which ranks as the eleventh largest listed investment company on the London Stock Exchange with a market cap of £2.3bn, and net assets of £3bn.

For him, the size of the trust – whose assets have floated around £3bn for the past eight years – is not the main concern; extracting value, enhancing performance and constantly refining the portfolio are his focus.

The portfolio owns 100 core infrastructure assets across a range of sectors. These include Affinity Water, HICL’s largest holding at 10.8%, hospitals, transmission towers, fibre broadband, toll roads, police stations, and highspeed railway. They span the UK, Ireland, Europe, North America, and New Zealand.

While these assets have seemingly little in common, Hunt said they are ‘united by simple principles’ of strong revenue characteristics, with either regulated or contracted revenues, a ‘monopolistic position’, and they are considered critical infrastructure.

‘They are all long-term assets offering long-term revenues, have a defensive market position, and provide critical infrastructure,’ he added.

While Hunt aims to hold assets for the long-term, since 2012 he has rotated assets to ‘consistently improve the portfolio’. For example, around £509m of assets have been traded in the past two years.

The cash has been used to replace assets with those that are more productive and to fund buybacks. HICL launched a £150m buyback programme earlier this year in a bid to tackle its persistent 20% discount and take advantage of a ‘compelling’ 11% return it calculated it could get on its own shares.

The decision to repurchase shares and effectively shrink the fund is a testament to Hunt’s belief that the trust does not need to grow ‘for the sake of it’. In his opinion, delivering strong net asset value (NAV) growth and dividends is far more important.

‘We could be a lot larger than we are but we made the decision to sell [£1bn] of assets,’ he said.

‘And we will keep doing that and will drive value in the portfolio, and refine the portfolio consistently…it is not just about accumulating more assets.’

Discount dilemma

The trust’s stubborn double-digit discount, currently at 23%, has been little moved by the buybacks so far. This may well be because the infrastructure sector continues to battle rising bond yields and higher-for-longer interest rates, which have both affected investor sentiment towards these funds.

Hunt said the industry as a whole needs to find a way to attract capital. He acknowledged that ‘buying back your own shares is not the most exciting way to attract people back’.

HICL has taken a more ‘holistic’ approach to its strategy. Hunt said this involves focusing on making sure the balance sheet is in good shape, repaying debt, and buying back shares to retire dividend obligations cheaply.

‘We have been performing really well,’ he added, noting that the trust has grown its NAV 2% over the past 12 months, and 9.5% over three years.

To encourage investors back to the infrastructure sector, the manager says the narrative needs to change. For many years investors sought out infrastructure and other alternatives as a source of income to counter low interest rates.

Now we are in an era of higher interest rates, some investors have eschewed alternatives in favour of other areas.

Nevertheless, Hunt was keen to flag HICL’s growth potential, as well as its attractive income. He splits the portfolio into ‘growers and yielders’, with the former making up 45% of assets, having made a concerted effort over the past eight years to expand this part of the fund.

The growers in the fund are ‘building up their capital base and investing in their capex model’ and should eventually become yielders, delivering consistent income for the fund.

Hunt said HICL offers income as well as an ‘exciting growth story’, with these assets growing 11% year-on-year and annual growth of 6% expected over the next decade, all delivered alongside a 7% yield.

‘It is a very strong total return proposition,’ he added.

Over the past three years, HICL’s shares are down 16.2%, including dividends reinvested, which compares to a 7.8% loss by the average fund in the AIC’s Infrastructure sector.