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Article | 01 May 2018 | Investments
Investors should be drawn back to infrastructure assets over time for their income protectionSolomon Nevins
Listed infrastructure funds have boomed in recent years as successive governments supported private finance initiatives (PFI) aimed at building and maintaining projects like schools and hospitals more efficiently.
However, the sector suffered something of a hammer blow in late 2017 due to increased political risk in the UK. Back in September 2017 Labour’s Shadow Chancellor John McDonnell talked about his party’s plans to nationalise PFI projects. This was based on an ideological view that the public sector should be in control of its assets but also a view that PFI had in some cases given quite poor value for money for the taxpayer.
The market took this prospect of nationalisation as a real blow to the heart. The relatively safe and steady asset class suffered sharp falls as a result. Compounding the problem at the start of this year was the failure of facilities management and construction services company Carillion. This added to the sense that private sector involvement in the provision of social infrastructure hasn’t been as effective for taxpayers as initially promised. Alongside other defensive, interest rate sensitive assets, infrastructure has also suffered from the new rising interest rate environment.
These three factors have taken infrastructure from a hefty premium to in some cases high single digit discounts.
There are a lot of hurdles before nationalisation on any scale can take place. First, the Conservative Party needs to lose the next election. This could either be via an unlikely early general election or at the next planned general election which is not for several years.
But even if we get a Labour Government there is an enormous cost to nationalising assets. This would require a huge amount of borrowing and would be hard for even a strong Labour majority government to push through. If it was to happen it is likely to be a long, drawn out process. By this time many of the existing PFI projects would be nearing the end of their life.
While the cost of the private sector providing services, such as schools and hospitals, may look expensive, the cost of government borrowing needed to bring these services back in house is likely to be significant. You also need to consider the quality of both the original building and the asset maintenance, which is generally very high with the private sector.
What is certain is a future Labour government would not write more PFI contracts, but we have already seen this type of financing reduce significantly. This is a real, long-term risk for the sector.
Investors should be drawn back to infrastructure assets over time for their income protection. This is on the basis that their incomes are growing and that if you are looking at these companies on a dividend yield basis they will look cheaper and cheaper over time. But the market is fickle. We have had such a long time of very low interest rates; adjusting to a higher rate environment is not going to be a smooth or peaceful process. There is likely to be some distress and volatility.
There is definite risk in this sector but we still view the current discounts as attractive. We don’t think nationalisation is a likely outcome for the majority of the current PFI assets. This prospect has been the main driver for the weakness in the asset class, which is why we believe it has been overdone.
Although, as I’ve learnt from dealing with my two-year-old daughter, just because something might be a bad idea and you tell someone not to do something, it doesn’t mean they won’t go ahead and do it anyway.
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