Infrastructure trusts in ‘uncharted territory’

Infrastructure trusts are facing a “complex and time-consuming” process of handing back assets to the government, as a number of the projects they invest in approach their expiry date. Some trusts also have the added difficulty of replacing assets built through public private partnerships (PPP) and could lose value as a result, Stifel analysts have warned.

The three main ‘core’ infrastructure trusts, HICL Infrastructure (HICL), International Public Partnerships (INPP) and BBGI Global Infrastructure (BBGI), have significant investments in PPP and private finance initiative (PFI) deals. These are typically contracts with the government to run social infrastructure services such as schools and hospitals and generate inflation-linked returns. This brings in regular and government-backed cash flow. But the trusts do not own the buildings, so when the concessions end, the assets are no longer part of the portfolio.

The contracts tend to run for 20 to 25 years, after which the responsibility for handling the service goes back to the government authority in question. Since the UK government said it would stop using the PFI model in 2018, new investments are not an option. Stifel analysts said that the handing back process is uncharted territory for the trusts and is likely to become “complex and time-consuming”. 

“The listed funds have not seen any of their larger and more significant projects come to the end of their concession periods so far… The whole process is likely to be a learning experience for all parties,” they added. The end of some of these contracts is now approaching. HICL, for example, is due to hand back 11 per cent of its portfolio in the next 10 years; INPP has a first handback due in 2025, and BBGI has two in 2026 and 2027. 

Towards the end of the decade, these funds could be moving into their repayment phase, where cash remaining in the expiring projects is paid to shareholders through dividends or capital repayments. At the same time, portfolio valuations are expected to decline, unless the proceeds are directed towards new investments.

New investments seem unlikely in the short term, partly because infrastructure trusts are trading at a discount to NAV and are unable to issue equity. Mick Gilligan, head of managed portfolios at Killik & Co, said HICL, INPP and BBGI are focused on paying down debt and may later turn to share buybacks. “Either way I am not sure there will be much in the way of new investments being made any time soon,” he said. 

But Stifel analysts expected the trusts to eventually go back to trading at a premium, which would allow them to make new investments and push the capital repayment phase further down the line.

A risk shift

If this does not happen, these trusts could gradually become smaller in the future. They also face a change to their risk profile, which has in part already materialised. HICL and INPP have reacted to the lack of new PFI projects by investing more in other types of assets, which have a higher return potential but are riskier.

These can be regulated investments, such as HICL’s holding in water supply company Affinity Water or INPP’s investment in gas transmission network Cadent, or even digital infrastructure.

These investments add diversification to the portfolio and have a longer life compared with PFIs. But they can also be more economically sensitive, have less inflation linkage and be exposed to demand risk. “Some investors may view the shift away from PFI and government-backed cash flows as a style drift and be less inclined to invest in the sector,” Stifel analysts suggested.

Out of the three, INPP now has the lowest exposure to PPPs at 40 per cent as of 30 June 2023, but has more in regulated assets at 50 per cent. As of September 2023, 63 per cent of HICL’s revenues were contracted, 17 per cent were demand-based and 20 per cent were regulated. Meanwhile, BBGI has stuck with government-backed revenues, but has lower exposure to the UK, with investments in countries where new PPP projects are still available. 

Gilligan suggested that the difference in approach could be partly due to the different incentives. “The managers of HICL and INPP are incentivised to grow the size of their asset base as they are remunerated by a NAV-based management fee. BBGI on the other hand is an internally managed company, without an explicit management fee, and is incentivised via several metrics including NAV growth and total shareholder return,” he explained.

James Carthew, head of investment company research at QuotedData, said that ultimately it is “a case of picking the fund that suits your risk appetite”, with BBGI at the conservative end of the spectrum, HICL and INPP “not a lot riskier”, and 3i Infrastructure (3IN) and Pantheon Infrastructure (PINT) looking more speculative.

He also noted that recent transactions by HICL and INPP demonstrate that infrastructure assets are still “changing hands and at pricing that underpins the validity of the NAVs and brings into question the discounts that these funds trade on”. This could make them buyout targets, he added.

In the short term, the performance of infrastructure trusts remains uncertain. The sector enjoyed a partial rerating off the back of improved interest rate expectations, with the AIC’s infrastructure sector up 8.8 per cent in the three months to 15 January. But Stifel analysts said that the sector is showing a high correlation with gilt yields, and as such, “this rerating may pause in the next few months, until interest rate cuts actually happen”.