Investors who have continued to buy infrastructure investment trusts in spite of their high prices have been warned they are largely untested in a rising interest rate and inflation environment.
Paul Locke, analyst at Westhouse Securities, said many infrastructure trusts – favoured by investors for the income they pay – have seen their share prices rise to significant premiums above the value of their net assets.
The average premium on infrastructure trusts last week was 15.4 per cent, meaning the shares are valued at more than 15 per cent above the value of the trust’s assets.
Investors have been hunting for income as interest rates and inflation have continued to fall in the UK.
However, Mr Locke has warned that the trusts have been “relatively untested” when rates and inflation are on the rise.
He said the risks to premiums on the funds came from a number of angles but the main two were rates and inflation.
“The marginal attractiveness of the fund yield is lowered as interest rates rise,” he said.
“In current terms, if your bank is paying you near zero and these are paying a 5 per cent yield, they appear attractive. If your bank moves to paying you, say, 2 per cent interest in the next year, then that yield gap looks far less attractive.”
While infrastructure trusts have varying degrees of inflation-linked protection under the terms of the contracts on a specific asset, Mr Locke questioned how quickly the value of the trust’s assets and the underlying contracts would adjust to reflect a higher interest rate and inflation environment.
“This suggests that as inflation rises, there will be a delay in the retail prices index
adjustment within the net asset value,” he said. “For instance, it might be revisited once a year on a preset month, so the
net asset value actually falls in real terms in the short term until the contract terms play catch-up.”
Mr Locke acknowledged it was “impossible” to say where future premiums on infrastructure trusts would go, but warned investors about the price being paid for shares now.
“My argument here is that on some of these funds you are paying what is effectively more than three-plus years of income in the form of a premium and that this is unsustainable,” he said.
“Current buyers are significantly overpaying at present levels for an average yield of 5 per cent. You can get that yield elsewhere with vastly less premium risk.”
Mr Locke said something like renewable energy trust Foresight Solar, which offers a 6 per cent yield and is on a small premium, could be a better choice for investors.
Winterflood Securities analyst Kieran Drake said he had “sympathy” with the concerns given infrastructure trusts had “only been tested in a falling rate environment”.
However, he said even though the inflation protection in the trusts was not a “one-for-one hedge”, it was still there.
He added that while the clear indication was that rates would rise, the move was expected to be gradual.
Trust numbers
15.4% – The average premium infrastructure trust shares trade on above the value of their assets.
£21.3bn – Total assets in property funds, according to the IMA.
