This shift in policy has been widespread and gained momentum quickly. Following last year's vote to leave the EU, the chancellor Philip Hammond hinted that the government would be prepared to increase borrowing to plough into infrastructure projects to generate growth and help the economy adjust to the ‘shock’ of Brexit.
But it is not just at home where the authorities could be looking towards infrastructure to generate growth. In Europe and Japan, the European Central Bank and the Bank of Japan have both recently mentioned that looser fiscal policy may be required to boost economic growth. However, the election of Donald Trump in the US has generated the most interest, with one of his biggest undertakings to "make America great again" being seen as spending big to regenerate the country’s dilapidated infrastructure
Such a shift in economic policy has been a key driver of the recent resurgence of interest in the asset class. So what are the key issues to consider if looking to add exposure to client portfolios.
When thinking of infrastructure, the first things that come to mind are roads, railways and airports. Infrastructure investing is about transportation networks, of course, but it is far broader and nuanced than that.
Infrastructure is also about those assets that provide essential services and facilities necessary for a society and economy to function. These assets include hospitals, schools, power generation and delivery, and more recently satellite communications and mobile towers. These are essential socio-economic assets, most of which are either financially backed or regulated by governments.
There are two defined approaches to invest in infrastructure. First, is investing in vehicles that will have direct exposure to infrastructure projects; because of the long-term and illiquid nature of infrastructure assets such exposure is gained via closed-ended investment trusts. Such trusts will typically be focused towards public finance initiatives and public private partnerships whereby public infrastructure projects are financed by private funding.
The other route is through the stock market, where equity investors can get access to this area of investment through listed infrastructure beneficiaries. Funds investing in listed infrastructure will focus on companies involved in provision of toll roads, airports, ports, railroads, utilities, pipelines, satellite and mobile towers. This route is more accessible and provides more liquidity and transparency than investing directly in infrastructure projects.
Benefits
There are a wide number of compelling reasons for investing in infrastructure:
• Income generation: infrastructure assets tend to be cash generative and so tend to produce regular, stable income distributions, an attractive prospect in this lower for longer interest rate environment and this has been a key driver in the increased desirability of the sector.
• Resilience to the economic cycle: infrastructure projects are generally used to provide vital services, whose usage means they are resilient and stable during periods of economic downturns. This non-cyclical element has been sought after in a climate of low global growth.
• Inflation hedge: at a time when inflationary pressures are once again concerning investors, revenues from certain infrastructure assets (eg toll roads) are often inflation linked, either through a regulatory framework or contractual obligations.
• High barriers to entry: projects typically require significant capital investment and have long lead-in times, which create barriers to entry for new competitors.
• Defensive attributes: infrastructure assets are generally long-dated assets and so are generally lower risks than broader equity markets and so relatively defensive during periods of equity market weakness.
• Government underpin: a high degree of private sector infrastructure spend generates revenue from long-term contracts with the public sector or public sector-backed clients. This provides security to the asset class’ income streams.
Drawbacks
• In the low interest rate environment, attractive income flows have been in high demand and this has pushed up the valuations of infrastructure assets; the UK-listed investment trusts trade on double-digit premiums, which provides a reason to be cautious.
• If we do start to see the interest rate cycle turning this could prove to be a detractor for areas of infrastructure that behave like bond proxies. Regulated utilities could be particularly under pressure and highly geared projects could be exposed to higher borrowing costs.
• A significant increase in infrastructure spending may act as a headwind for long-term investors. The euphoria to invest in the sector could lead to short-term demand seeing valuations reaching unsustainable levels. But also If ‘Trumponomics' does result in a sharp upturn in growth this could lead to interest rates rising quicker than expected, dragging on interest rate sensitive areas.
We gain exposure primarily through listed infrastructure funds. Although these form part of our equity allocation, rather than a separate asset class, we like infrastructure shares for their low beta attributes which provide a hybrid between bonds and wider stock market indices.
Infrastructure is a global investment theme and so provides investment portfolios with global equity diversification. Funds that we regard highly in this area include First State Global Listed Infrastructure and Lazard Global Listed Infrastructure Equity Fund. They complement each other well in adopting different investment styles and prefer different areas and market regions.
For investors looking for passive exposure iShares Global Infrastructure ETF is a low cost option, with a portfolio focused on utilities, transportation and energy.
If looking at investing in trusts that have direct exposure to infrastructure projects then the VT UK Infrastructure Income fund merits consideration. The fund invests in portfolio of closed ended Uk listed vehicles with a focus on generating a high income and providing inflation protection.
The chart demonstrates how strongly both listed equities investing in infrastructure and trusts investing in direct projects have performed over the past five years, according to Financial Express Analytics (as at 17 January 2017), bid-to-bid, net income reinvested.
Looking ahead, I do not expect to see the levels of returns achieved over the past five years based on current valuations. In 2017 higher bond yields could prove to be a headwind and we believe that it will be important for managers to be selective and move away from expensive bond proxy areas to seek value. In an uncertain political backdrop, the risk of regulatory interference could also weigh on utilities.
But bond yields have already spiked post Trump and I am not of the belief that inflationary pressures or further material interest rate rises (that are not already priced in) are on the cards for some time. Trumponomics will not happen overnight and indiscriminate selling could provide opportunities.
I believe infrastructure will remain a steady defensive long-term investment theme with attractive income generating qualities. But, for those looking to exploit the shift to fiscal spending there may be more cyclical areas that will see greater benefits.
Gavin Haynes is managing director of Whitechurch Securities Wealth Managers
Key points
Infrastructure funds have received more attention recently with the promise by politicians of infrastructure spend.
Income generation is a strong reason to invest in infrastructure.
Bond yields have already spiked post Trump.
