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Are infrastructure investment trusts overpriced?

09 December 2016

With low interest rates, many investors have turned to infrastructure investment trusts for income but are they overpriced?

By Rob Langston,

News editor, FE Trustnet

The search for income has been a key theme for investors in recent years as historically low interest rates, plunging yields in government bonds and demand for dividend-paying stocks intensified the hunt for yield.

In a recent note Winterflood Investment Trusts highlighted the rise of alternative income investment trusts, driven by the low rate environment and the appeal of the closed-end funds for the asset class.

According to data from Winterflood, the infrastructure sector has an average net yield of 4.8 per cent, as at 9 December, while the infrastructure-renewable energy sector is yielding 5.9 per cent.

 “The infrastructure sector has been the shining light in this theme and, with an aggregate market cap of £12.4bn, it is larger than any other single income-focused sector,” it noted.

Performance of the sector compared with other income generating strategies has also been favourable over recent years.

The average infrastructure investment trust has generated a 44.81 per cent total return over the past three years, according to data from FE Analytics, compared with a 13.92 per cent return for the average trust in the IT UK Equity Income sector and 9.87 per cent for the IT Debt sector.

Performance of selected income-focused sectors over 3yrs

 

Source: FE Analytics

The best performing investment trust over three years is 3i Investments, which has generated a return of 81.03 per cent, as at 8 December.

Strong performance has also been reported by Vietnam Infrastructure, up 66.96 per cent, International Public Partnership and HICL Infrastructure have also reported strong double-digit returns of more than 40 per cent


For the investment trust sector, the Brexit referendum contributed to discount widening earlier in the year as markets reacted to the political and economic uncertainty caused by the result, although this has largely fallen back more recently.

However, as the popularity of alternative income strategies has increased so has the cost of funds in the infrastructure sector, with infrastructure investment trusts trading at significant premiums.

 “A combination of demand for yield and scarcity of assets in the UK has driven both capital growth for these funds and also seen extended premiums,” Winterflood noted.

“In the wake of the Trump-inspired sell-off in the bond market it appears that these premiums had become over-extended in certain areas of the infrastructure sector.”

The average infrastructure investment trust is currently trading on a premium of 13 per cent, according to data from Winterflood, while the average renewable energy infrastructure fund discount stands at 9.7 per cent.

Discount/Premium of 3i Investments over 5yrs

 

Source: FE Analytics

“Premiums in the social infrastructure sub-sector had become highly correlated with gilt prices, becoming ‘bond proxies’,” Winterflood added.

“With some funds falling by as much as 9 per cent over the last three months, which is equivalent to circa two years’ worth of dividends, it has been an important reminder that the solid income generating characteristics of the assets can be overlaid with share price volatility that impacts total returns.”

While, yield remains sought after, other investment trust sectors might offer more attractive propositions given the premiums in the infrastructure closed-end fund space.


Trusts in the Bonds/Debt sector have an average net yield of 6 per cent, whilst trading at a 1.3 per cent premium, latest Winterflood data shows. Elsewhere, the IT UK Equity Income sector has an average net yield of 3.8 per cent on a discount of 3.6 per cent.

“It remains difficult to determine how quickly interest rates will increase, but over the lifetime of current portfolios held by infrastructure funds – circa 20-25 years - it seems likely that they will,” Winterflood added. “If increases come quicker than expected, then premiums are likely to decline.

“However, these funds continue to offer a number of attractive attributes, including strong yields generated by robust cashflows, often backed by government, and a degree of inflation protection.

“The highest yields and highest levels of sensitivity to inflation are to be found in the environmental/renewable energy infrastructure sector, where premiums are, in general, lower than in the social infrastructure sub-sector, although the gap has closed recently.”

Indeed, the outlook for the sector remains optimistic with president-elect Donald Trump pledging to increase infrastructure spending in the US during the election campaign.

In the UK, chancellor Philip Hammond also pledged to increased infrastructure investment in the Autumn statement, although economists and fund managers were less bullish about the impact of plans.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.