How to build a portfolio with infrastructure assets

But one only has to consider the recent closing of property funds (at times of market stress) to understand that holding long-term assets within a daily traded open-ended structure can sometimes lead to liquidity mismatches when all investors are running for the same door, and we know this imbalance can often take time to correct. 

Discount/premium risk. Closed-ended infrastructure vehicles (investment trusts) do not suffer this issue but the share price can trade at a premium or discount to the value of the underlying assets.

At times of market stress investors have often had to accept substantial discounts being applied to share prices in order to be able to exit and move on. 

At the moment, because of their attractive return profiles, many closed-ended funds are trading on heavy premiums – in some cases over 20 per cent. This need not be an issue, but investors should consider what might cause this premium to be eroded away. 

The implied value of infrastructure assets is generally assessed on a discounted cash flow basis, and therefore the level of long-term interest rates is an important factor within the valuation process.

Expectation of a change in the interest rate cycle and higher longer-term interest rates would result in future cashflows being discounted at a higher rate, thereby reducing their implied present value.

We are already seeing the beginning of a steepening in the yield curve in the US.

At the same time, the improving economic environment that would likely accompany rising interest rates may improve the relative attractiveness of more traditional yielding assets such as corporate bonds and commercial property and draw capital away from infrastructure.

We are already seeing the beginning of a steepening in the yield curve in the US. It remains to be seen whether this continues.  

Inflation risk. Many infrastructure assets have a degree of inflation sensitivity built into the negotiated contracts.

This means that levels of inflation that sit within the bounds deemed to be acceptable by central banks will have a positive effect on infrastructure assets.

However, sustained spikes in inflation to unexpected levels could lead to knee-jerk reactions from central banks keen to put the genie back in the bottle and, as mentioned above, materially higher interest rates would be a likely negative for the infrastructure sector. 

Political risk. Another consideration is political interference.

The Labour party under Jeremy Corbyn had a very dim view of old-style private finance initiatives (PFIs).

At the time of the last election there was concern that public/private partnership contracts would be re-written and assets taken into national ownership with inadequate compensation. It is an illustration of the political risk facing infrastructure anywhere.