Yesterday brought news that well-respected infrastructure fund HICL Infrastructure is part of a consortium that has agreed to acquire 100% of the High Speed 1 Project from Borealis Infrastructure and Ontario Teachers’ Pension Plan Board. HICL and funds managed by Equitix will each acquire a 35% interest, with the balance being acquired by third party funds managed by InfraRed Capital (HICL’s manager). According to fund analysts at Numis “HICL’s share of the consideration amounts to £320m, although following completion, HICL intends to bring in minority co-investors, managed by InfraRed, representing up to £120m of its commitment. The investment will be funded using HICL’s existing cash resources and drawing under its £400m Revolving Credit Facility. On completion, HICL will have a net funding requirement of c.£140m”.
Alan Brierley of Canaccord Genuity was typical of many fund specialists in welcoming the deal. In his view “the acquisition of this strategically important and core UK asset is consistent with HICL’s strategy of investing in assets which are positioned at the lower end of the risk spectrum. The acquisition is accretive to the portfolio with regard to total return, yield and inflation correlation……We believe that HICL has a key role to play in improving portfolio diversification; we expect it to continue to deliver superior long-term returns and it remains a long-term constituent of our model portfolio. The shares have experienced a sharp de-rating in the past year but we regard this as an attractive buying opportunity. HICL offers an attractive yield and genuine capital preservation characteristics, and we believe these have significant value, particularly when we reach the next phase of the cycle.”
So, sounds great news, yes? Maybe. Most of the analysts seem to have picked up a vital point. This deal increases the fund’s exposure to what are called demand based assets, with a much greater sensitivity to the economic and business cycle. According to Brierley at Canaccord “ HS1 will represent around 7% of the portfolio and will take exposure to demand-based assets to 16% (vs. a limit of 20%). We would expect revenues here to be stickier than other economically sensitive assets, while we note that the traffic risk is mitigated by a 20-year operating history.” That point is echoed by Numis who observe that a string of recent deals (including utility firm Affinity Water) “ have had a significant impact on the inflation correlation of the portfolio which stood at 80% at 31 March, up from 60% a year ago. However, investors will also note the increased correlation to GDP from 9% to 16%. It will be interesting to see how this new variable will impact returns through the economic cycle. From an investor sentiment perspective, we believe it will be crucial for managers to clearly highlight additional return sensitivities that may arise from new investments, particularly as many invest due to the low correlation to the wider economy and other asset classes.”
In simplistic terms, HICL might have become that little bit riskier and its’ shares a bit more volatile. Its return profile might now start to move more in line with the overall business cycle – and thus thstock marketet cycle. That could be an issue for those investors who bought into the fund expecting an uncorrelated investment – though I’ve always treated that argument with a pinch of salt as the infrastructure funds are listed entities and thus their share price will inevitably move up and down somewhat based on the general stock market cycle. In truth, I think this all perfectly manageable for HICL. It just needs to increase its reporting and be sensitive to the issue of sensitivity.
With most core infrastructure funds trading at a 10% premium – HICL is a little lower at 8% – my only real concern is that the premium might erode even further, possibly down to 5%. With yields running at around 4.5% across the sector, this might be attenuated by a (limited) sell off in core fixed income assets such as investment grade bonds. The resulting increased yields from these conventional income assets might push some income investors away, pushing infrastructure yields closer to 5%.