Given the low interest rate environment prevalent since 2009 and the decline in bond yields over the past eight years, investors seeking an attractive yield are looking at alternative assets, and at infrastructure in particular. While the yields on offer are attractive, do investors fully understand the asset class and are the risks clear?
Since 2006, a number of investment companies have listed on the London Stock Exchange and these have grown in scale as their investment proposition has attracted further investors. Some of these investment companies now have a 10-year track record, showing consistent and robust performance, including during the financial crisis.
Today there are three main groups of LSE-listed infrastructure investment company:
• five infrastructure funds focused principally on making equity investments into core infrastructure assets;
• three infrastructure debt funds investing in debt lent to infrastructure assets; and
• six renewables funds which invest in operational renewable energy assets such as wind farms and solar parks.
Their shares are traded like any other listed equity. A number have traded for a considerable time at sizeable premiums to their prevailing net asset value per share, which brings with it the risk that share prices may fall back to NAV at some point in the future. It should be noted though that even at these price levels, these companies offer yields and potential total returns that should prove attractive to many investors on the basis the shares are held for the long term.
The listed investment companies have a closed-ended structure which is more suitable for investing in underlying illiquid infrastructure investments. There are a number of open-ended infrastructure funds that tend to invest in listed infrastructure corporate entities, such as companies that manage infrastructure assets such as airports, ports, toll roads and water companies.
While the 14 closed-ended funds all invest in infrastructure, their returns and the risks underlying their portfolios vary. The infrastructure asset class is often described as though it is one homogenous group of comparable assets, but in reality the asset class encompasses investment opportunities with a broad range of risk/return profiles.
When considering an infrastructure investment, key points to consider include:
• How predictable the income stream is. For example, PPP projects have contractual availability payments based on performance, whereas an airport is dependent on the number of passengers and hence usage.
• How predictable the costs of managing and running the infrastructure asset are. The greater the contractual certainty on costs and expenses, the more predictable the investment return.
• The level of leverage. Infrastructure assets are normally financed with debt (secured against the project cash flows) and equity. The level of leverage should be appropriate to the infrastructure asset type. In the past, a number of toll roads were financed with too much debt and when traffic levels did not meet base case, they struggled to pay their debt costs.
Some of the advantages of investing in infrastructure projects include:
• Attractive long-term returns. By their nature, infrastructure assets are essential for the functioning of society and tend to feature long-term (or in perpetuity) cash flows.