The attraction of infrastructure

Suddenly, governments seem to have woken up to the need to invest in infrastructure. In the US, a central plank in President-Elect Donald Trump’s strategy for economic revitalisation in the years ahead is a $1 trillion investment in key infrastructure. In the UK, the Chancellor’s Autumn Statement included a commitment to raise the share of GDP spent on key infrastructure projects. The European Union too has just announced new funding for infrastructure projects, primarily for digital telecoms networks.

For investors in the infrastructure sector, this must be good news. And these investors include around half a dozen investment companies – closed-ended funds that represent the only practical option for retail investors and their advisers looking for exposure to infrastructure.

Most public-sector infrastructure projects are structured along broadly similar lines. The provider – whether an investment company or another type of private sector operator – puts up the cash to get the project built or developed, and often also has a role in running it. In return, governments make regular payments to them over the life of a long-term contract.

This model has a number of attractions. First, since the payments come from the government, the fund is effectively earning an income backed by a state guarantee. Also, contracts usually provide for inflation-proofing, so the fund is guaranteed a real return on its money. Moreover, in most cases, the income is payable whether or not the infrastructure is used (though in cases such as toll-roads, additional payments may be made that are linked to revenues).

No wonder infrastructure funds have proved so popular with investors. They pay attractive levels of income – the closed-ended funds in the Infrastructure sector currently offer yields of between 4 and 6 per cent – that are tough to beat in this low interest rate environment. Plus the revenues underpinning that income are backed by the state and include inflation protection.

The catch is that this allure is expensive. Shares in all the leading infrastructure investment companies currently trade at chunky premiums to the value of the underlying assets – more than 10 per cent in most cases. In other words, investors are expected to pay over the odds for the assets that the funds hold.

That makes these funds potentially vulnerable to shifts in investor sentiment – were investors to begin to feel less positive about the sector, there is scope for a correction even if there is no change to the value of the underlying assets at all.

What might prompt such a shift? Well, if investors thought they could get decent levels of income elsewhere, they might be less happy to pay so much for it in the infrastructure sector. Given that we’ve seen a rise in US interest rates in recent days – probably with more to come – as well as a post US election boost for bond yields, that’s a credible scenario. It’s worth saying that most infrastructure investment companies are relatively new constructs – they’ve been launched since developed markets moved into the ongoing period of extraordinarily low interest rates and haven’t been tested in other environments.

The other possibility is that investors become more fearful about the creditworthiness of governments, in which case they might begin to question the value of guaranteed income. Again, with public debt so high – and rising – in most Western economies, this isn’t out of the question.

Nevertheless, for investors and advisers with their eyes open to these risks, infrastructure is likely to continue to be potentially attractive during 2017. And government commitments to new projects on both sides of the Atlantic should, over time, provide a stream of new investment opportunities for investment companies and other infrastructure players. Watch this space, in other words.