By Hugi Clarke, Sales Director, Foresight
As an asset class, infrastructure is more often than not associated with large institutional investors who buy stakes in trophy assets like Thames Water or Heathrow Airport, than with retail (private) investors. The fundamental appeal of infrastructure investments to institutions are the predictable cashflows - often index-linked and derived from long term contracts with governments, cities or municipalities or other blue-chip counterparties; the inherent protection from competition that comes with natural monopolies, regulated assets or concessions granted by public authorities; and the strategic importance of the assets to the UK and its economy.
What is often overlooked is that steady cashflows can be a particularly attractive feature for today’s retail investor, especially given the current low interest rate environment where reliable low risk yield is hard to come by. Historically a tough asset class for individuals to access, in recent years a number of innovations have brought down the barriers to entry for infrastructure, making it easier for private investors to invest in this traditionally defensive sector and better balance risk and volatility within their personal investment portfolio.
Most infrastructure assets are of significant strategic importance to the economy. Roads, railways, power stations, renewable energy plants and the like form the fundamental fabric of an efficient society. As a result, such infrastructure assets can often be actual or quasi-monopolies, whether by regulation as with Thames Water where they own the infrastructure to deliver water to every customer in London, or naturally such as with mobile phone network infrastructure where high barriers to entry limit competition.
Many retail investors find the long term secure contracts associated with infrastructure very appealing. Infrastructure assets play a crucial economic or social role, and so typically benefit from long term government backed contracts in the case of Private Finance Initiative (PFI) projects; government subsidies in the case of renewables; the ability, via regulation, to charge customers directly e.g. water companies / rail operators; or investment grade offtake contracts (as in the case of power sales to "big six” electricity suppliers).
Many infrastructure projects have a natural inflation-linkage due to the economic and contractual underpinnings. This is just as attractive for retail investors as for pension funds as a long term hedge against liabilities. Renewable infrastructure assets such as wind and solar have an explicit inflation-hedge through the structure of the government subsidies, which are index-linked to RPI, typically for 20 years.
Innovation in the fund management market has provided many ways for retail investors to gain exposure to infrastructure. Until recently, renewable energy producing infrastructure assets such as Solar Farms and Anaerobic Digestion plants qualified under the tax efficient VCT and EIS regimes. Significant sums were raised from private investors to help kick-start emerging renewable energy technologies before the schemes were deemed non-qualifying. Private investors looking for inheritance tax relief can still access the asset class through Business Property Relief (BPR) vehicles and investors looking for yield can secure attractive index-linked returns from renewables infrastructure investment companies like Foresight Solar Fund Limited, which, when held in an ISA or a SIPP, can deliver dividend income tax-free and attract no capital gains liability.
We’ve spoken largely about why infrastructure is an attractive area for investment, so where within this interesting sector are the best opportunities for retail investors over the next few years?
A transformational change is underway in global energy markets due to increased renewable energy generation, the phasing out of certain fossil fueled generation and a move towards more distributed and flexible energy generation and smart grids. In December 2015 at the Paris Climate Conference, 195 countries adopted the first ever universal, legally binding global climate deal which set out a plan to limit global warming to less than 2°C above pre-industrial era temperature levels. These factors are disrupting the traditional centralised utility-led power markets and presenting a number of interesting investment opportunities both to institutional and retail investors.
Both small scale flexible gas based generation and the nascent storage market look like they will play an increasing role moving forward as the most logical way to balance the intermittency of renewables. Whilst the UK Government has scrapped future renewable subsidies for solar and onshore wind, subsidies are still available for new offshore wind projects, and for nuclear it would appear. Retail investors can access UK renewables via listed fund structures such as Foresight Solar Fund Limited or its wind equivalents.
Flexible reserve power, energy storage and smart meters are opportunities the retail investors might want to take a closer look at, especially where, as in the case of smart meters, they qualify under EIS or VCT schemes. These opportunities have come about due to the increase in renewables penetration leading to a more intermittent energy generation profile with a resulting increased requirement for reserve capacity, incentives for new build power generation, and an increased requirement for frequency response generators with quick power-up times.
Other opportunities have been identified in waste infrastructure, and in particular various forms of waste to energy. This is an example of assets with strong fundamentals (unless we are going to stop throwing things away any time soon), some government underpinned revenues (renewable energy subsidies) and long term inflation linkage. The UK still has a long way to go in reducing its reliance on landfill for residual waste disposal and the sector will certainly require investment capital for the foreseeable future.
Smart data equipment is an asset class that is also receiving a lot of attention at the moment. The equipment comprises a smart meter which collects energy usage information for both electricity and gas, and supplies real time data directly to the energy suppliers. This is a major step forward for energy providers as the data collected will help match energy supply with demand. Smart meters also save the labour cost of sending people out to check meters, and they provide customers with energy usage information that will improve energy efficiency in the home as well as more accurate remote billing and the appropriate tariff according to their living or working environment.
Smart meters are an appealing infrastructure investment opportunity for retail investors because they are long term and predictable assets. They are low risk assets, they are a proven technology, they have no moving parts but can sit on a wall for anywhere up to 20 years, while warranties for smart meters are typically for five years and the usage agreements with energy suppliers go as far as to guarantee income for at least ten years.
The UK government has mandated that every house and business must have a smart meter installed by 2020, although current market views expect the programme to extend beyond 2020 due to the sheer scale of the rollout across the UK. This means that 53 million meters need to be installed in approximately 30 million premises across the UK over the next four years. To date, around five million have actually been installed, leaving the scope for investment very wide. In this £12 billion project, the vast majority of the meters will be in households; particularly fitting for retail investors as they will be able to see a tangible result not only of their investments but also of improved efficiencies of energy usage in the home.
Infrastructure is hardly a new asset class, but it retains its decades long appeal. Innovation from fund managers will continue to open up new market opportunities and investment vehicles so that an increasing variety of investors can participate.