Restructuring: Whitehall’s loosening grip on the public purse has benefits for the private investor, says Russell Taylor.
The chancellor’s Autumn Statement produced the expected outrage from committed Brexiteers. The economic forecasts were deliberately gloomy, a continuation of the pre-vote ‘Project Fear’, and ignored the successful six months of economic trading since the referendum.
Missing the point?
But economic and stockmarket forecasts are always wrong, as history shows and the Office of Budget Responsibility admitted itself, giving only a 50 per cent chance of success to its own expectations. There are too many variables to take into account, and no economist concerned for their job ever strays far from the consensus. Predictions in today’s world have the same function as examining an animal’s entrails in the Roman era: to give confidence to leaders making difficult decisions.
And the chancellor did indeed make a difficult decision – to break away from his predecessor’s belief that a nation’s finances were similar to that of the average household. They are not, and never have been. This pernicious monetary doctrine, insisted on through German domination of the euro, has an unhappy history.
It has brought deflationary misery to Europe and, with the new political crisis in Italy, may well bring further threats to the existence of the euro itself. George Osborne, faced with the spendthrift borrowing of the previous government, had little choice but austerity. Cutting back on welfare payments was one issue, while cutting back on infrastructure and capital spending was quite another. But the latter is always the most popular cut, since it does not directly harm the voters – only economic growth.
Purpose of monetary policy
A nation’s monetary policy is for the purpose of aligning the interests of the state – credit standing, infrastructure and services – and those of the people – full employment, well-paid jobs and business efficiency. The new chancellor, formerly a successful businessman, understands that. He has insisted that the Treasury accepts the need for additional spending on roads and rail, even though this will increase the time necessary to bring spending and tax-raising into balance.
This was also a focus of Donald Trump’s US election campaign – a $1trn (£788m) infrastructure spend to repair the inter-highway system built under the Eisenhower presidency more than 70 years ago, and committing himself to rebuilding America’s highways, bridges, tunnels, airports, schools, and hospitals. Much of this will also rely on private financing. Fortunately for the private investor, as Table 1 shows, the investment company industry has a thriving infrastructure sector.
Infrastructure as asset class
The closed-ended structure of an investment company provides investors with the purest way of accessing infrastructure projects, by investing in contracts to develop and run long-term capital expenditure projects in public sectors such as transport, healthcare and schools. These contracts are for the long-term (20 to 50 years) and aim to deliver a stable income over the period of the contract, often linked to inflation, and guaranteed by the government.
Annabel Brodie-Smith, communications director at the Association of Investment Companies (AIC), says: “Infrastructure has been the fastest-growing investment company sector of the past decade, with the closed-ended structure the ideal home for investing in long-term infrastructure projects. This is because managers have a stable pot of money and are crucially not affected by investor inflows and outflows.
“The infrastructure sector is currently trading on around a 14 per cent premium, reflecting the strong demand for alternative income. Of course, investors need to take a long-term approach to investing and premiums can turn to discounts if sentiment changes.”
HICL Infrastructure and International Public Partnerships were the trailblazers of the sector, both launched in 2006. By the end of that year, the sector already had total assets of £550m, which today have grown to more than £11bn. That makes infrastructure the investment company industry’s growth story of the decade, and its fourth-largest sector. An additional four companies were created during the past five years to participate in this attractive business, which is increasingly international in scope.
Letting locals decide
There is nothing new in the UK government’s plans, and a new pipeline of projects suitable for delivery through the public-private partnership (PPP) scheme will be set out in early 2017. These will cover economic and social infrastructure, and might also include opportunities in the social housing sector.
But what is new is that the government seems to have shifted away from deciding on big-ticket public infrastructure projects itself, adopting a more consultative and entrepreneurial approach to plugging the UK’s infrastructure deficit. As Giles Frost, chief executive of Amber Infrastructure, puts it: “Regions are now set to have increasing spending power to procure bespoke solutions for road, rail and housing projects. This fits with what looks like a social inclusion agenda by central government, seen most clearly in an effort to drive through improvements in broadband connectivity.
“Decentralising infrastructure spending will allow for more flexibility for private investors to take solutions to local authorities, and not simply rely on central government to provide a list of ready-made projects in which to invest.”
When to buy
Premiums to net asset values in this sector reflect the poor record of infrastructure spending of recent years; they may well disappear as the flow of projects increase. Normally the companies raise money by issuing new shares ahead of taking on a project, and investors should await these opportunities. But they should also check out the strategy of each of the sector’s six companies, as these are beginning to diverge as the sector matures.
As Numis Securities wrote recently: “International Public Partnerships has been steadily increasing the proportion of investments in regulated assets. This began in 2011 with its investment programme into the offshore transmission sector. More recently, it has continued with investment into the Tideway Tunnel project in 2015. Both of these primary assets operate in an established and predictable regulatory regime, overseen by Ofgem and Ofwat, respectively.
“On completion, International Public Partnerships’ stake in Gas Distribution Network will be its largest investment and will significantly increase the inflation linkage of its cashflows. We believe the company has been differentiating itself from the wider listed PPP infrastructure peer group through its strong origination capabilities, providing access to a range of attractive deals, on a risk-adjusted return basis.
“We note that a number of the company’s listed peers have been targeting a broader range of assets, with HICL and John Laing Infrastructure recently announcing the addition of a number of GDP-linked, demand-based assets.”
For private investors, this is a strong income-producing investment sector, significantly safer than gilts when it comes to the risk of capital loss, and with inflation protection on offer from some assets. In a very uncertain world, and at a time when UK GDP may start to decline again, it is hard to think of a safer investment.
