Keeping it real

With global inflation running hot, assets that can preserve the real value of investors’ capital are more relevant than ever. ‘Real assets’ such as property, infrastructure, renewable energy infrastructure, farmland and forestry and leasing are often thought of as offering protection against rising prices. Investment companies investing in real assets now manage £56 billion.

The Association of Investment Companies (AIC) has spoken to investment company managers from four sectors: Infrastructure, Property – UK Commercial, Property - Europe and Leasing about how they are handling rising inflation, the risks of inflation to their asset class and where they are finding opportunities.

Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC), said: “Real assets can offer diversification to portfolios, as well as some inflation protection. However, they are hard to access in daily-dealing open-ended funds, as the suspension of many property funds during the pandemic reminded us. The investment company structure provides a tried-and-tested way of accessing these assets while being able to trade your shares whenever the stock market is open.

“Investment companies investing in property and infrastructure have been around since before the financial crisis. The infrastructure sector has delivered strong returns of 196.6% over the past ten years and has a relatively stable yield of 4.6%. The pandemic clearly had an effect on some companies in the UK Commercial Property sector which has delivered a return of 87.8% over the past ten years and has a yield of 4.6%.

How are real assets providing protection against inflationary pressure?

Phil Kent, Manager of GCP Infrastructure Investments, said: “52% of GCP Infrastructure’s portfolio of investments has some form of inflation protection, meaning that in a higher inflationary environment, the income generated by the portfolio will also increase. This provides investors with a hedge that protects their returns from the impact of higher inflation on discount rates and valuations. By way of an example, the updated, higher Office for Budget Responsibility (OBR) inflation forecasts published in October contributed a one pence per share uplift in the published net asset value of GCP at the end of December.”

Simon Lee, Co-Manager of LXI REIT, said: “Our portfolio is expected to continue to deliver attractive, defensive inflation protected income returns and capital growth to our shareholders going forward, in part as our portfolio has 96% of rental income index-linked or fixed uplifts. Inflation-linkage is just part of the creation and protection of value and outperformance that we deliver for our shareholders over the long term.  

“We acquired our portfolio predominantly off-market through pre-let forward fundings and sale and leaseback strategies, at an attractive average net initial yield of 5.6%, which is 110 basis points above our current portfolio valuation yield of 4.5%. Our portfolio also has a long weighted average unexpired lease term to first break of 22 years.  It is 100% let or pre-let to over 70 institutional-grade tenants with strong financial covenants across a range of defensive and structurally supported sub-sectors sectors, including grocery and industrial.

“Meanwhile our recent acquisitions have further diversified our portfolio, including areas such as life sciences and education, and clearly demonstrate our ability to create additional value for shareholders by sourcing attractive opportunities.”

Louise Cleary, Manager of Value and Indexed Property Income Trust (VIP), said: “As at 30 September 2021 the trust had 92.4% of contracted rental income on index related leases. The last quarter of 2021 has been busy with new property acquisitions which has increased the indexation further. The trust’s shareholders are therefore well placed to benefit from the current surge in inflation, which will feed through into increased rents, earnings and, in due course, valuations for the trust. Additionally, the trust has largely fixed rate borrowings, which will provide attractive gearing to these inflationary benefits. Rent collection levels have been high throughout the pandemic, emphasising the quality and resilience of the portfolio’s tenants.”

Paulo Almeida, Manager of Tufton Oceanic Assets, said: “Shipping tends to perform very well in periods of high inflation and we have been explaining this to the investor community for the past 12 to 18 months. Ships in operation tend to increase in value more than new builds in inflationary periods because steel, machinery, energy and labour are the key cost drivers. In the three five-year periods of high inflation in the past 50 years, ship values increased 80 to 200%.”

Nick Preston, Manager of Tritax EuroBox, said: “We are successfully implementing our strategy, acquiring prime assets in excellent locations, extracting value from the existing portfolio and continuing to advance our ESG agenda. We have a stable diversified income profile with compounding annual indexation in 78% of our leases. Leasing and asset management captures rental growth. Our acquisitions are through trusted development partners, with further value being delivered through speculative forward funding and investing in building extensions/development, as well as profitable sales. These help us to deliver a strong financial performance and meaningful dividend growth.

“Our market remains highly attractive, with strong occupier demand driven in particular by the accelerated growth of e-commerce, combined with limited supply of large, high-quality and sustainable space to rent in prime markets. We see attractive opportunities to add assets to the portfolio that have built-in value creation opportunities and remain confident of delivering further growth.”

The outlook for inflation

Louise Cleary, Manager of Value and Indexed Property Income Trust (VIP), said: “We are concerned that the current bout of inflation may endure, caused by the tardy response of the Bank of England to the surge in prices. Higher interest rates are clearly a risk for property valuations but there remains a significant gap between gilt yields and property yields that should protect property investors as interest rates rise.”

Phil Kent, Manager of GCP Infrastructure Investments, said: “My expectation is that higher inflation will not persist over the medium-term. The combination of higher costs, particularly energy, contributing to the significant inflation we are seeing currently, and prospect of higher interest rates, are likely to ultimately serve as a brake on demand growth, ultimately reducing costs.”

Paulo Almeida, Manager of Tufton Oceanic Assets, said: “We don’t try to forecast inflation but we believe most of our investors are concerned about potentially sustained high inflation, and shipping tends to perform well in this environment.”

John White, Co-Manager of LXI REIT, said: “Inflation growth is forecast to be materially higher than the forecast for open market rental growth and there is further government tolerance for increased inflation to erode the value of the national debt. Forecasts for inflation from the Office for National Statistics (ONS) are 3.2% in 2021, 4.1% in 2022 and 3.5% in 2023.”

What are the best opportunities to invest in?

Nick Preston, Manager of Tritax EuroBox, said: “The occupational market is increasingly favourable and we expect the trends of strong occupier demand, driven by e-commerce and the reinforcement of fragile supply chains, to continue in the long term. When considered alongside a limited new supply of logistics space, we expect consistent, sustained rental growth in prime logistics markets. We are confident of being able to extract further value from the existing portfolio through asset management and development activities, as well as other activities.

“We are well placed to continue delivering the company's strategy through growth in new investments which we are able to continue to access.”

Simon Lee, Co-Manager of LXI REIT, said: “We look forward to deploying the proceeds of the recent raise swiftly and prudently into our pipeline of long-let, inflation-linked assets diversified across a range of defensive and structurally supported sub-sectors and leased to strong tenants, all of which we expect will create further sustainable value for our shareholders.

“Our portfolio continues to perform strongly, benefiting from the embedded inflation linkage in our rents, and its exposure to attractive sub-sectors of the real estate market including grocery and industrial. Meanwhile our recent acquisitions have further diversified our portfolio, including in areas such as life sciences and education, and clearly demonstrate our ability to create additional value outperformance for shareholders by sourcing attractive off-market properties and forward funding opportunities.”

Phil Kent, Manager of GCP Infrastructure Investments, said: “The most attractive opportunities are focused on infrastructure investments that support the wider transition to net zero. Historically, government support and investment has focused on the decarbonisation of electricity generation through renewables such as wind and solar. These sectors have become highly competitive and less attractive on a risk-adjusted basis as a result.

“GCP has an excellent track record of identifying new asset classes within infrastructure that benefit from public sector support and investing in these before they become less attractive. The wider energy transition, including flexible generation and storage, hydrogen, the decarbonisation of our heating and transport systems, carbon sequestration and controlled environment food production are all likely to be areas benefiting from attractive government support mechanisms in the coming years.”

Louise Cleary, Manager of Value and Indexed Property Income Trust (VIP), said: “Last month, we were pleased to announce the acquisition of five freehold index-linked properties for a total cost of £30.5 million at a 5.6% net initial yield, bringing the current total portfolio average yield to 5.7%. The five properties purchased were three industrial/warehouse units in Chester, Stoke on Trent and Westbury, a petrol filling station in Melton Mowbray and a supermarket in Newport, Isle of Wight. They all had index-linked leases, an average unexpired lease term of 10 years and were let to MKM Building Supplies, Arla Foods, BP Oil and Marks and Spencer. VIP is now almost fully invested after its transition to a predominantly property trust.”

Risks to real assets

Paulo Almeida, Manager of Tufton Oceanic Assets, said: “High valuations of containerships was a risk to our portfolio. We have addressed this by selling them at attractive prices and reducing our percentage of assets in containerships from 40% to 10%. We have re-allocated that capital to other segments, bulkers and tankers, with below mid-cycle valuations and/or higher yields.”

Nick Preston, Manager of Tritax EuroBox, said: “While the Covid-19 pandemic has been challenging for society, it has served to reinforce the importance of the logistics sector as a whole, and especially highlighted the critical nature of sustainable supply chains. In particular, it has accelerated the adoption of e-commerce and encouraged companies to shorten and simplify their supply chains. Occupier demand for assets has therefore continued to grow while occupational supply remains constrained, creating a supportive investment environment for long term asset owners such as us.

“We continue to construct a portfolio which is diversified by geography and tenant and that generates a high and secure level of inflation-linked income, as well as capital growth, which will in turn support and deliver the total returns and dividends we are targeting.”

John White, Co-Manager of LXI REIT said: “We seek to minimise the risks of our business and portfolio by investing in long-let, inflation-linked assets diversified across a range of defensive and structurally supported sectors.  These are leased to a wide range of strong tenants, predominantly making off-market investments and forward funding opportunities. We deploy our capital swiftly and prudently to avoid cash drag into an identified portfolio of investments and use long term debt with a low fixed cost. This helps to ensure that we can deliver further attractive inflation-protected income returns and capital growth for our shareholders over the long term. We find and create value through our strong relationships which provide access to off-market opportunities, and through seeking out assets and sectors that are likely to deliver enhanced value to our portfolio and shareholders.”

Phil Kent, Manager of GCP Infrastructure Investments, said: “GCP’s risk framework identifies four areas of investment risk, which vary based on the specific asset class. These are: (i) market risks, such as exposure to electricity prices or inflation; (ii) credit risks associated with reliance on the performance of customers or suppliers; (iii) operational risks associated with building or operating real assets; and (iv) legal and regulatory risks, such as corporation tax or change in law. Recently, the high volatility seen in the energy markets, and associated volatility of revenues received by renewables presents both risk and opportunity.”

-ENDS-

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Notes to editors

1. The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment. Today, the AIC represents a broad range of closed-ended investment companies, incorporating investment trusts and other closed-ended investment companies and VCTs. The AIC’s members believe that the industry is best served if it is united and speaks with one voice. The AIC’s mission statement is to help members add value for shareholders over the longer term. The AIC has 360 members and the industry has total assets of approximately £269 billion.
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