How to invest in wind farms, motorways and mobile phone masts

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It’s official. A chunk of your pension should be in infrastructure.

That is according to the government and the financial regulator, which have spent six years finding a way for pension funds to diversify into assets such as roads, bridges and airports, alongside other types of illiquid assets that cannot be bought and sold quickly, notably private equity.

Now the first Long-Term Asset Funds (LTAFs) have started to go live, so savers can begin investing.

The main reason for holding infrastructure when investing for retirement or any other long-term goal is diversification — the need to not have all our eggs in one basket. With stock market volatility far from over, infrastructure bulls are claiming the sector looks attractive, offering an inflation hedge and an alternative to sometimes unpredictable equities.

They point to the sector’s potential to align with investors’ environmental, social and economic considerations, with key types of infrastructure playing a central role in building a greener future.

Plus, the sector is set to benefit from the UK government’s £650bn infrastructure investment programme; elsewhere, other governments are launching similar schemes, including US president Joe Biden’s $1.2tn bipartisan infrastructure law and the EU’s Global Gateway.

But, as bears of the sector point out, a fair wind for infrastructure projects does not guarantee plain sailing for investors. Governments are often guided more by politics than economics, fall out with private partners and change policies with elections. There is a long list of schemes with cost overruns, management disputes and technical failures.

So, investors need to take care. But the LTAFs’ launch suggests the time is ripe for a good look at infrastructure. FT Money investigates.

Stable returns in volatile times

Infrastructure investment covers water, energy, roads, airports, railways, ports, satellites and communications systems. It includes education, border security and healthcare. Or as Ed Simpson, the head of energy and infrastructure at investment advisers Gravis, neatly puts it: “The basic physical structures and facilities that are needed for the operation of society.”

He says investments in schools, hospitals and renewable energy generators can be considered lower risk than assets exposed to the economic cycle. “Even during the pandemic, when people were not going to schools, these assets continued to earn revenues — they were paid for having the assets available, regardless of whether they were in use.”

This defensive capacity is a powerful draw, with proponents also pointing to infrastructure’s lower volatility (or less bumpy ride) compared with global equities. Infrastructure equity performed better during years of weaker equity performance such as 2011, 2018 and 2022, according to research from M&G comparing the FTSE All-World index with the FTSE Global Core Infrastructure index. Meanwhile, research from ClearBridge Investments found that during 21 market sell-off episodes identified since 2005, global listed infrastructure stocks outperformed global equities 67 per cent of the time, delivering excess returns above global equities of 2.7 per cent on average.

Other benefits are higher dividend yields, based on inflation-linked revenue streams. The average dividend yield in the Association of Investment Companies’ infrastructure sector is 6.6 per cent, which compares well with returns on equities — the FTSE 100 has an average yield of 3.68 per cent.

Ben Yearsley, director of Shore Financial Planning, says: “I’ve used infrastructure as [a] core holding for well over a decade now. The combination of stable inflation-linked income (in many cases) and defensive characteristics make it a fascinating asset class.”

Why is the income stable? Alex Moore, head of collectives research at Rathbones, says that utilities, in particular regulated utilities, dominate the infrastructure universe, which means earnings tend to be more contractual in nature, returns more controlled by regulators, and often with a degree of inflation linkage.

At times when the stock market is rising strongly, infrastructure’s performance can certainly look dull. But in the long term, the sector can provide not only income but also some capital growth.

Profit from going green

A key driver today is the global co-ordinated push towards green climate goals, reducing pollution and protecting natural environments.

In the US, President Biden has triggered a dramatic economic shift with his 2022 Inflation Reduction Act aimed at encouraging greater use of renewable energy and green technologies via tax credits and subsidies.

Moore says: “The US is the largest geographical area within the global infrastructure universe, so tends to feature heavily in ETFs and actively managed funds. This could provide greater opportunities to invest in companies that are beneficiaries of the act and have the means to generate renewable energy, especially regulated utilities.”

And there are other opportunities. Gordon Smith, head of fund research at Killik, says the infrastructure sector will play a huge role in the digitalisation of industry — one of the most significant developments in the global economy over the coming decades.

“The exponential growth in data traffic is set to accelerate as both 5G enables greater functionality in settings such as manufacturing and increased computing power brings forward the potential of functions such as AI,” he says.

Beware of regulatory risk

But remember, some infrastructure is riskier than others. When constructing a portfolio, Killik distinguishes between social infrastructure (such as hospitals and schools) where often government-backed cash flow is received; regulated assets (such as utilities) paid a return based on the size of the underlying asset base; user pay assets (such as a toll road) where payment is received based on use and therefore there can be variability from the economic environment; and fully competitive unregulated assets subject to supply and demand risk.

Even heavily regulated infrastructure is not immune to risk, especially political risk. Just look at the current debate about the UK water industry. Moore says: “Many companies operate in regulated industries such as water and electricity. This means that their earnings might be set by regulators [and] provides a degree of certainty, but also means their future returns are out of their hands.”

Some areas of infrastructure can also be demand-driven in nature; for example, toll roads and railways. “These areas are not as cyclical compared with consumer-facing companies, but demand can be impacted by macroeconomic factors,” says Moore. “This was seen in extremis during Covid lockdown.”

Experts at Killik also warn that the value of infrastructure assets and the financing structure of infrastructure businesses can (like all yielding assets) be highly sensitive to changes in inflation and interest rate expectations. This is a significant consideration for assets often designed to last 30 or 50 years.

When researching investments, it is important to distinguish between listed and unlisted infrastructure investments. One option is to buy investments in the equity of companies involved in the provision or maintenance of infrastructure. Typically, these are priced daily and tradeable on stock exchanges. For example, the biggest holdings in the iShares Global Infrastructure UCITS ETF (an easy way to hold the big players) are US infrastructure group NextEra Energy and US transport group Union Pacific, with National Grid the only UK firm appearing in the top 10.

The other option is unlisted infrastructure. Traditionally such assets have been the domain of governments but in recent decades a combination of privatisation, public-private partnerships and regulated private investment in infrastructure have opened the sector to financial investors.

Investment options abound

Investors are thus not short of options for their portfolio including for tax-efficient self-invested pensions (Sipps) or individual savings accounts (Isas). Most retail investors do not access the sector through direct stakes in companies but via collective investments, where professionals can weed out the duds.

The main choice is between open-ended funds and closed-ended investment trusts. The Investment Association, which represents open-ended funds, launched a dedicated infrastructure sector in September 2021. These 29 funds invest primarily in equity of companies involved in infrastructure and may be diversified by region or have a specific focus.

But if you want to access a mix of listed investments plus direct investments in unlisted projects look to the investment trust sector, where there has been a phenomenal expansion of opportunities over 20 years. Back in 2013, there were just six infrastructure investment trusts, with £4.3bn of assets. Today the total infrastructure sector is worth £34.7bn, spread across three sectors — nine companies in traditional infrastructure, 22 in renewable energy and two infrastructure securities companies investing in listed infrastructure stocks.

Interactive Investor, the investment platform, says the investment trusts Greencoat UK Wind, The Renewables Infrastructure Group, Gore Street Energy and NextEnergy Solar have dominated purchases from its sustainable investment recommended lists in the year to date.

The amount you hold in infrastructure will depend on your timescale and attitude to risk — consult an independent financial adviser if unsure.

The MSCI PIMFA Private Investor Growth index, which reflects a growth-oriented investment strategy, has a 10 per cent allocation to ‘alternatives’, which usually comprise infrastructure alongside private equity. Shore Financial Planning’s Yearsley says: “I’d have between 5 and 10 per cent of a portfolio in infrastructure.”

So, even for investors ready to buy, exposure should be pretty limited. But it is worth having something in this particular pot.