With interest rates potentially on a downward trajectory, there’s good reason (as we highlighted last week) to believe that the bumper yields on offer from government bonds might not be here for too long. But a competing theory suggests that we could instead return to an ‘old normal’, where the yield on the likes of the 10-year UK government bond stays somewhere between 4 and 5 per cent for a longer period.
Why should anyone but the most ardent economist care? For one, it would mean that a decent income would still be available to investors from the bond market (albeit capital gains would be scarce), and that less ‘safe’ assets will have to offer better yields, and better total returns, to get their attention.
It would also have an effect on how certain asset classes fare in future. And so, we turn back to the infrastructure investment trusts, which remain popular with investors even after a difficult period and currently trade on some attractive share price discounts and dividend yields.
Analysts at Stifel have posited that gilt yields could remain higher – on the basis that the UK government is continuing to issue a hefty amount of bonds and may well continue to do so in future. As such, they have considered how some of the best known funds in this space fared when gilt yields were previously at the 4 or 5 per cent mark.
The verdict is broadly positive: the team notes that sector stalwarts HICL Infrastructure (HICL) and International Public Partnerships (INPP) operated in an environment of higher yields back in the late 2000s, but nevertheless saw their shares command sizeable premiums to net asset value (NAV).
That reflects the fact that investors liked the positive inflation linkage such portfolios have, as well as their low level of correlation with equities and reasonably high dividend yields.
In the present day, Stifel accordingly thinks the sector is on a good footing even if gilt yields remain elevated. That’s thanks to the trusts’ own high yields that are often backed by government-backed cash flows, as well as the fact they offer decent value thanks to the wide discounts on which they trade.
There are issues that are worth highlighting. The sector now comes with lower capital returns, higher economic exposure, the risk that public-private partnership (PPP) assets need to be handed back, discount volatility and the prospect of some professional investors selling down. That, and a high level of correlation to gilt yields, could mean a rocky ride for investors.
The team believes that funds with a high exposure to PPP assets are most sensitive to shifts in yields, given that they have government-backed cash flows. As such, investors should keep a close eye on how these portfolios evolve in future.
To give one example, we recently highlighted the fact that HICL has been shifting away from such assets for a variety of reasons. That makes it a punchier offering in terms of its risk/reward status, but could also provide some notable advantages in terms of future returns. BBGI Global Infrastructure (BBGI), by contrast, has remained totally focused on the likes of PPP assets.
Other considerations are also worth bearing in mind, including the fact that funds operating in less mature infrastructure sectors might be more exposed to the gyrations caused by yield moves. What’s more, an era of higher rates inevitably raises questions about the returns on offer from other alternative asset classes such as private equity. Even an ‘old normal’ can still have new implications for investors.