PFI and infrastructure investment companies

Investment risk comes in many forms, but it’s fair to say September’s Labour Party conference wasn’t on the radars of advisers and investors scanning for hazards in the road for their portfolios.

But when shadow chancellor John McDonnell announced that a future Labour government would seek to nationalise the UK’s private finance initiative (PFI) contracts, one sector of the investment company industry sat up and took notice. Most infrastructure funds have substantial exposure to PFI contracts in areas including education, health, energy and transport – were they being threatened with being forced to sell up, possibly at a knockdown price?

Six weeks or so after Mr McDonnell’s speech, it’s clear that investors in infrastructure funds haven’t dismissed such a prospect out of hand. The premiums at which shares in funds in the sector trade relative to their assets have narrowed markedly since conference season.

Indeed, over the past few days, shares in one such fund, the John Laing Infrastructure Fund, have even traded at a discount, for the first time since the investment company’s launch seven years ago. That follows a trading update from the fund in which it warned it would lose 14 per cent of the value of its portfolio of UK PFI projects if Labour were to bring every one of them back under Government control.

There are two points to make here. First, funds such as JLIF are quite right to evaluate the impact of a proposed change in Government policy on their portfolios – and to keep investors informed. And second, it’s a pretty big step from where we stand today to the outturn JLIF is imagining; frankly it’s a step that seems pretty much inconceivable, even if Labour do form the next government.

Not least, it’s important to look at what Mr McDonnell actually said. While his promise to “bring them back” won cheers from Labour Party conference delegates, the party was at pains to explain after the speech that it was committed only to a review of PFI contracts. A Labour government would then bring them back in-house only “if necessary”.

Given the estimated £50bn cost to taxpayers of ending the PFI contracts early and the other priorities that the shadow chancellor has already set out – including renationalisation in industries such as rail and water – one imagines the “if necessary” bar will be high. Mr McDonnell may not think PFI offers good value for money – others would disagree – but he is also a pragmatist. Even if he does want out of PFI, he’s more likely simply to let existing contracts run their course while not agreeing any further initiatives.

In fact, many on the left of politics still see a role for institutional investors such as investment companies in providing finance for large-scale investment in infrastructure. The influential Institute for Public Policy Research, for example, argues that “relying solely on public funding and finance [to fund capital investment] is not always feasible or desirable”. Realistically, a Labour government committed to infrastructure investment would continue to look to the private sector, at least in part, for funding.

All of which brings us back to infrastructure investment company valuations. In truth, the correction of the past few weeks partly reflects the high valuations that have been common in the sector in recent times – infrastructure funds represent a fantastic source of diversified income from a portfolio of assets benefitting from an implicit government guarantee; in this time of low interest rates, that has seen investors flock to the sector.

Even so, it seems reasonable to make the case that the sell-off in the sector has been somewhat exaggerated. And even if investors aren’t now considering infrastructure for tactical reasons, many will remain attracted to the sector on a strategic basis – there simply aren’t many other assets that offer the risk-return profile available here, and closed-ended funds are the only way into infrastructure for the majority of investors.

None of which is to suggest that these funds are suitable for everyone, or even that cheaper valuations represent a buying opportunity; just that this is a sector that still has enormous appeal to many investors, Labour government or not.