In times of market stress, infrastructure investment funds tend to be viewed as a safe haven by many investors.
This is because the income generated from infrastructure assets is typically paid by the government, or a quasi-government agency, providing a similar level of security to bonds.
Examples could include renewable energy assets, hospital buildings or roads – the latter often built under private finance initiatives.
But often the income is inflation-linked, which provides a cash flow that may be durable during tough economic times.
Yet over the past six months, the AIC Infrastructure sector has lost 11 per cent.
James Sullivan, head of partnerships at Tyndall Investment Management, says one of the issues faced by these funds is that, as bond yields have risen, the income available from infrastructure becomes relatively less attractive.
Generally speaking, income-bearing assets are priced relative to bond yields, but also at a premium to this, known as the risk premium. The size risk premium varies across different asset classes, and may be quite low for an asset such as infrastructure, but if bond yields are rising, then the total yield required to make other asset classes attractive must also rise.
This calculation is then extrapolated over multiple years to create what is known as the discount rate, that is, an attempt to place a value today on an asset based on the future cash flows generated by that asset.
Three years ago (September 2019)
One year ago (September 2021)
Most recent (August 2022)
(Sector did not exist)
Renewable Energy Infrastructure
Source: AIC (total assets, stated month end)
Mick Gilligan, a partner at wealth management firm Killik and Co, says: “Think of the discount rate as the level of ‘compensation’ that you would need for taking on the risk of the investment. Lots of risk equals high discount rate. Very little risk equals low discount rate.
"A receipt of £100 in a year’s time discounted at 10 per cent is worth £90.91 today (100/1.1=90.91). If the cash flows are very predictable the discount rate should be lower. So, £100 in a year’s time discounted at 5 per cent is worth £95.24 today (100/1.05=95.24).
"There are two components to the discount rate. There is the risk-free component – the risk-free rate, typically government bond yields that provides compensation for waiting (that is, the time value of money). And there is the risk premium component – the element that reflects the risk of default or delay on the underlying cash flows.”
Sullivan points out that as bond yields rise, this causes the long-term value of the cash flows generated from an infrastructure asset to decline, meaning the capital value of the physical assets owned by infrastructure funds has fallen, and this will be reflected in the valuations of the funds.
Because physical assets are not priced on a daily basis, in the way that listed equities and bonds are, it may take some months for infrastructure funds to mark down the value of the assets they own, and that would reduce the net asset value of infrastructure investment funds.