Infrastructure trusts safe bet for rate rise

Strong cash flows, a favourable regulatory environment and decreasing market correlation make listed infrastructure investment companies attractive despite the threat of rising interest rates, say analysts at Canaccord Genuity.

In a report on the sector, the stockbroker claims fears that rising interest rates will adversely affect infrastructure trusts are misplaced as the sector boasts strong fundamentals.

One of its most redeeming features is its strong track record of consistent and increasing dividend payments, which Canaccord claims are "comfortably covered by underlying cash flows" that are often underpinned by long-term inflation-linked contracts with public sector bodies.

In addition, the broker says that the renewable infrastructure sector also benefits from a stable regulatory framework and subsidies providing revenue stability in early years.

Misplaced fears

With yields ranging between 5.5% and 2.3%, Canaccord believes that infrastructure trusts will remain attractive as and when the Bank of England does finally raise interest rates as hikes will be small and incremental.

"A key concern we encounter when discussing listed infrastructure is the potential impact of higher rates and there has been much noise recently about the timing of the first rate rise.

"We believe these fears are misplaced; it is difficult to envisage a scenario which would lead to a material rate increase or a return to pre-crisis levels. Mark Carney recently forecast that UK rates would stabilise around 2.5% in 2017, a level which is half pre-crisis levels," says the broker.

In addition, Canaccord claims that infrastructure funds offer good portfolio diversification with the correlation of the sector to the FTSE All Share index standing at just 0.12%.

"Since March 2006, the [infrastructure] sector has delivered a shareholder total return of 95%, comfortably ahead of the FTSE All Share total return of 58%, and these excess returns have been achieved with two-thirds of the volatility," says Canaccord.

These strong returns are reflected in valuations, with almost all infrastructure trusts currently trading on significant share price premiums to their net asset values (NAVs).

The most expensive on a relative basis is Bilfinger Berger Global Infrastructure Trust, which is currently trading on a 17.6% premium to its NAV at a share price of 119.5p. The only trust trading at a discount is Foresight Solar Fund (FSFL), with shares priced 1.1% below its NAV.

However, Canaccord claims that in the case of closed-ended infrastructure funds, this traditional approach to valuation is "far too simplistic".

"Given the long-term nature, predictability and covenant of the underlying cash-flows, we believe that a yield-based approach to valuation is of equal importance and given the margin above risk-free investments, we remain wholly comfortable with current valuations.

"Indeed, if and when the music stops, the sector's ability to continue delivering absolute returns could represent significant value. We believe listed infrastructure should form a cornerstone of a diversified investment portfolio and we remain overweight," Cannacord says.

In its summary of recommendations, the broker has 'buy' ratings on the following vehicles: BBGI, GCP Infrastructure, Greencoat UK Wind, HICL Infrastructure, John Laing Environmental (JLEN), John Laing Infrastructure and Renewables Infrastructure (TRIG).

Canaccord rates 3i Infrastructure as a 'hold', but has a 'sell' rating on International Public Partnerships, citing issues with balance sheet management and a debacle over incentive fees, which has "done the company, sector or industry few favours".

Shareholder total return on £100 invested, AIC infrastructure sector