Infrastructure – an income seeker’s solution in a COVID-19 world?

Infrastructure investments can offer income from a variety of vital assets such as utilities, roads, hospitals and schools.

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  1. Rob Morgan

The COVID-19 crisis has had a huge impact on UK dividends. Many companies have cut or cancelled pay outs, and the effect could continue for some time. As a result, many investors have been looking to plug a gap in their income streams. Bonds offer a more reliable income, albeit without the growth or recovery potential, and infrastructure investments could also help offer a solution.

Infrastructure assets such as roads, power networks, hospitals and schools are often backed by long-term revenue streams from local or central government.  As the demand for infrastructure services is normally fairly constant, investors are drawn to them in their search for reliable income. A motorway river bridge can, for instance, represent a near-monopoly route, and may have scope for raising toll prices over time. Meanwhile, revenue from water, gas, broadband and other utility-style infrastructure tends to be fairly stable, and the provision of key buildings such as hospitals, schools and prisons are often uncorrelated to the wider economy altogether.

Investing in infrastructure could also offer some resilience in the event of rising inflation. Infrastructure companies often have little competition so can increase prices without affecting demand much. However, it can also be a complex area and there are a number of risks to contemplate. Due to local or national importance, key infrastructure is often highly regulated. Although governments are often reliable, long-term partners, there is always the possibility they can intervene and, in extreme cases, reduce or constrain an investor's return, for instance through revoking licences or nationalising assets or projects.

In relation to the COVID-19 impact, most global infrastructure is operating without significant disruption with workers in utilities and important infrastructure projects generally designated key workers. However, ‘demand-based’ infrastructure assets such as roads and public transport are seeing declining revenues. That’s an issue for investors in these assets, especially where an investment is structured as equity rather than debt – and dividend income can be expected to be lower in the near term.

Direct infrastructure investments through investment trusts

Infrastructure projects worth millions if not billions of pounds are not something an ordinary investor can get directly involved with. Fortunately, there are ways to get around this. One is through specialist infrastructure investment trusts that pool investors’ money and use their specialist expertise to invest in a number of projects and companies they think will make good long-term investments. The 'closed ended' nature of investment trusts makes sense for this area as its only really possible to finance projects with a fixed pool of capital committed for the long term.

Large, diversified investment trusts such as International Public Partnerships, HICL and 3i Infrastructure invest across a wide range of infrastructure assets in the UK and overseas. Their dividends are presently attractive and well covered by predicted earnings and reserves, so they can potentially provide investors with a decent income-orientated return and welcome diversification from equity and bond markets.

HICL Infrastructure invests in essential public assets – roads, water, schools and hospitals. 75% of the portfolio by value is invested in the UK, with 17% in the Eurozone and 8% in North America. This diversification via a mix of sectors, geographies, currencies and revenue models is important. It combines complementary areas to mitigate exposure to any one factor, be it a single counterparty or macroeconomic trend. The Trust seeks to provide investors with long-term sustainable dividend income whilst also maintaining and growing capital for a 7-8% a year total return target. Among the largest assets in the portfolio with ‘demand-based’ revenues vulnerable to the COVID-19 economic slowdown are the A63 Motorway in France and the Northwest Parkway in the USA, and these have understandably seen a fall in revenue in recent months.

3i Infrastructure focuses on economic infrastructure and new build projects, principally in Europe. It targets a progressive annual dividend payment of 5.5% of net asset value per year, with an expected total return of around 8-10% per annum. The investment approach used by 3i Infrastructure is different to HICL in that it targets only 10% in traditional PFI (government partnered) assets, owning a wide array of operating companies such as offshore telecom networks, electricity transformers, switchgear and cables, wind farm maintenance support ships, airport ground support equipment and oil storage terminals.

According to the company, to date, any operational impact from COVID-19 pandemic has been limited and, currently, all portfolio companies are maintaining continuity of service to their customers. TCR, the airport ground handling equipment business, is the most obviously affected by a dramatic fall in air travel.

International Public Partnerships (INPP) invests directly and indirectly in public or social infrastructure assets (usually via entities which have been granted a concession to build, operate and manage those assets) and related businesses located in the UK, Australia, Europe and North America. It seeks to deliver sustainable long-term returns through growing dividends. Cash flows benefit from a high degree of inflation linkage and are very long term in nature. Unlike HICL and 3I it invests almost exclusively in availability-based projects, rather than demand-based which have less predictable revenues. As such it has a heavy weighting in regulated assets.

There are two projects where the COVID-19 impact has been notable. The Thames Tideway Tunnel (London’s new ‘super sewer’ and 9.2% of NAV) temporarily reduced operational activities and maintained only essential and safety-critical works during full UK lockdown. As a result, some degree of extra cost and delay is likely, though activity is now back up and running. In addition, Diabolo Rail Link (8.6% of NAV) serves Brussels airport and has approximately 75% of revenues related to either the usage of the airport link or the wider rail system in Belgium.

Investing in infrastructure company shares through a fund

An alternative route is to invest in shares of companies that operate infrastructure or vital utilities. Picking individual shares can lead to a lack of diversification, so another option is a fund specialising in these. These should offer a broad range of holdings by sector and geography while still producing a decent income from a flow of underlying dividends.

One option our Collectives Research Team rate highly in this area is Legg Mason IF RARE Global Infrastructure Income Fund. The RARE team are experienced infrastructure specialists based in Australia and have built an impressive record whilst consistently delivering a decent yield, though past performance is not a guide to the future. The fund invests in companies around the world operating in infrastructure related sub-sectors. The fund is exposed to both regulated assets (gas, electricity and water utilities) and to ‘user pay’ assets (toll-roads, airports, rail and communication towers).

The regulated and contractual nature of the portfolio’s revenues means greater visibility around future dividends, which is clearly important in the current climate. RARE estimate 80% of the portfolio will experience little to no hit to earnings from recent events, 10% will experience a modest hit and the remaining 10% will experience a material earnings impact that will in many cases impair their ability to pay a dividend.

The worst hit companies by COVID-19 restrictions are those with demand-based revenues, such as toll road operators and airports. Fortunately, the fund is skewed away from these names in favour of US and European utilities, which have more resilient cashflows. RARE estimate the portfolio’s current forward yield to be 5.4% when adjusting for future dividend cuts or suspensions. Please note this is only an estimated forecast by the manager and is in no way guaranteed.

Our view

The global infrastructure sector has been growing for many years and is expected to continue getting bigger in the future. For income investors especially, it remains an interesting alternative to more traditional components of a portfolio.

There is an element of political risk to bear in mind, and at a project or single company level there are a myriad of variables that can impact operations and profits. As with any investment area diversification makes sense. There is also the general risk that assets with reliable income streams have become expensive in an era when bond yields have collapsed to exceptionally low levels. Should bond yields rise, that might only be partly mitigated by any inflation protection at a project or company level.

Please note funds mentioned have been thoroughly researched by Charles Stanley’s Collectives Research Team, but none are part of our Foundation Fundlist of preferred funds for new investment at the time of writing.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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