52
infrastructure
investor
may
2014
SPECIAL FEATURE
UK listed infrastructure funds have enjoyed strong tailwinds in recent years.
Tom Skinner
of Dexion Capital investigates whether investors should now
be cautious in a more challenging environment
Worth the risk?
u k
l i s t e d
i n f r a s t r u c t u r e
The use of public-private partnerships
(PPPs), known as the Private Finance Ini-
tiative (PFI) in the UK, accelerated from
the late 1990s onwards. These contracts
have not been without their controver-
sies (mainly from the perspective of cost
to government) but they have become
fixtures of many governments’ financing
repertoires andmore governments have
adopted their use over time.
The London Stock Exchange listed
PPP/PFI infrastructure investment com-
pany universe has flourished over the last
eight years, driven by favourable demand
and supply characteristics. Total net assets
in the sector now amount to £3.6 billion
(€4.4 billion; $6.0 billion) across four com-
panies: HICL Infrastructure (£1.4 billion
innet assets), International Public Partner-
ships (£0.9 billion), JohnLaing Infrastruc-
ture (£0.8 billion) and Bilfinger Berger
Global Infrastructure (£0.5 billion).
However, the success of these strate-
gies, combined with a more developed
track record for the asset class and man-
agers, has attracted more capital to the
sector (directly or indirectly), at a time
when the dynamics of available investment
opportunities has also changed. The sector
faces new challenges and investors face
some additional risks.
DEMAND AND INTEREST RATES
Weighted average discount rates have
remained largely unchangedover the past
few years, resulting in expanded PPP/PFI
project risk premiums as reference sover-
eign interest rates have collapsed. Similarly,
over the same time frame, publicly traded
corporate credit – whether investment
grade or sub-investment grade – has seen
significant yield and spread compression.
The consequence of both of these fac-
tors has been significant appetite for the
equity of listed PPP/PFI infrastructure
funds. Over £2 billion has been raised in
the last three years. The amount of capital
that could be raised in any periodwas very
much driven by ability to deploy it.
The 30-year-long government bear
market appeared to reach its trough
between mid-2012 and mid-2013. The
UK 20-year gilt yield was just above 2.5
percent in May 2013, but subsequently
rebounded to 3.5 percent, its highest
level since mid-2011, and currently sits
at 3.4 percent. Meanwhile, valuation dis-
count rates have decreasedmarginally and
quoted shares have consistently traded
significantly higher than net asset values;
all of which means that the effective risk
premium being priced into the shares of
listed infrastructure investment companies
is closer to 300 basis points (bps). The con-
tinued normalisation of long-term inter-
est rates will further reduce the relative
attractiveness of investment companies at
current valuations.
Nevertheless, current discount rates
remain elevated enough that they can to
an extent absorb further increases in inter-
est rates, and a strong argument can be
made that the asset class has matured to
such anextent that riskpremiums onPPP/
PFI infrastructure assets should bemateri-
ally lower than pre-crisis levels. Therefore,
on a fundamental view, we believe that cur-
rent valuations are resilient for long-term
interest rates of 4.5 percent or below.
However, there are some technical
risks associated with this, as the resilience
of investor appetite for the asset class in the
listed sphere, in a rising interest rate envi-
ronment, remains largely untested.While
the listed infrastructure companies are
large and liquid, if large investors reduce
HICL INFRASTRUCTURE WEIGHTED AVERAGE DISCOUNT RATES
AGAINST 20 YEAR UK GILTS
Source
: Dexion Capital
10
6
8
4
9
5
7
3
2
Sep-08
Percent (%)
Sep-10
Sep-09
HICL Infrastructure weighted average project discount rate
20 year UK gilt
Sep-11
Mar-13
Mar-09
Mar-11
Sep-12
Mar-10
Mar-12
Sep-13
