The British infrastructure trust market is a mixed bunch of mostly smaller and specialist vehicles. The market capitalisation of the 32 trusts under consideration is close to £25 billion ($32.7 billion; €29.6 billion), at the time of writing, and the weighted average discount to NAV was 16.7 percent. This despite all of them being OECD-focused and with a majority invested in on-trend energy transition-related assets.
Within the group, there are considerable differences. Trusts focused on hydrogen, battery storage and digital assets were trading at an average discount of 50.1 percent at the time of writing. Bigger and more diversified trusts fare better on average. But all are faced with the impossibility of raising fresh capital even as the opportunity set is expanding.
How do managers of such funds make sense of the market? And what will it take to improve their lot? Infrastructure Investor approached several managers, all of whom were eager for the tide to change.
The NAV question
At the heart of the discussion over share price is the disconnect between what managers think the assets are worth and what the listed market is willing to pay. The consensus among managers is that their NAVs are fair and that the low share price is less a reflection of the value of the assets and more a wider structural issue.
“If anything, the NAVs in the sector are too conservative in some cases, compared with where assets can trade in the private market in a
well-run process”
David Bird
Octopus Renewable Infrastructure Trust
“Valuation is not a perfect science. We do see different funds or investors taking different views on valuation for perfectly valid reasons,” says Philip Kent, CEO of Gravis Capital and manager of infra debt-focused GCP Infrastructure Investments.
Typical reasons for variations in the approach to valuing include differing forecasts of the price of power and inflation as well as assets’ expected life term.
Richard Lum, CIO of Victory Hill that manages VH Global Sustainable Energy Opportunities (GSEO), favours transparency.
“We are one of the most open in terms of how the NAV is produced out of all our peers. Valuation-wise, we take a very, very orthodox M&A approach using the capital asset pricing model. Investors can do their own calculations based on that.”
The Octopus Renewable Infrastructure Trust uses PwC renewables valuation specialists, according to its fund manager, David Bird. “A lot of external review goes into NAVs, notwithstanding that the initial preparation is frequently by the managers.”
Generally, there is a strong sense of the product being underappreciated by listed market participants.
“The NAV is what we can sell assets for in private markets,” says HICL Infrastructure’s fund manager, Edward Hunt.
“In the cashflows, you’ve got strong inflation correlation, you’ve got growth, and the private market is in a better position, in our view, to value those cashflows than the listed markets.”
Realising at a premium
The proof is in the pudding, and so far, realisations have indeed been in line with or above valuations. HICL sold a UK-based portfolio of five operational infrastructure assets that represented its overall mix last October with the stated agenda of wanting to demonstrate that the NAV was robust. A GCP wind farm sold earlier this year at a 6 percent premium to NAV, and valuations seem to be holding up too at ORIT.
“There remains a wide pool of capital looking to deploy into our sector,” says Minesh Shah who manages The Renewable Infrastructure Group (TRIG).
“If anything, the NAVs in the sector are too conservative in some cases, compared with where assets can trade in the private market in a well-run process,” says Bird. ORIT sold two Polish wind farms at the end of 2023 for a price more than 20 percent higher than the NAV. Aquila European Renewables sold a share in a Norwegian wind farm at a 10.8 percent premium at the beginning of September.
With no lack of dry powder, particularly in the energy transition space, Bird isn’t worried about the valuation side of things. “There is liquidity. Probably less than there was in the middle of 2022, but it’s still there.”
The assets sold may have been cherry-picked, of course, but at this time there is no evidence pointing to NAVs generally being inflated.
A perfect storm
While valuations look to be holding up, the share prices have been hit by a perfect storm of other factors. Most trusts were set up in a low-interest rate environment to provide core-style returns. Then things changed.
“As interest rates went up, and with inflation going up, investors started reallocating and liquidating their positions, which provided a lot of sellside pressure on share prices,” says Lum.
Conversely, the recent gentle slide in interest rates has seen share prices rise and discounts to NAV tighten for all but the most challenged trusts. But there is still some way to go as investors are inclined to see investments in infrastructure trusts as a bond proxy. Something that fund managers discourage. ORIT’s Bird voices a typical complaint:
“When comparing the yield from listed infrastructure vehicles to gilts, not enough weight is put on the inflation protection… If we were trading at NAV, our income yield would be about 6 percent. Right now, it’s more like 8-9 percent. Compare that to real yields on bonds rather than nominal yields and our risk premium is too fat.”
Further, a now about-to-be-scrapped regulatory insistence on counting costs twice has made investments in listed funds look comparatively expensive and hence discouraged retail customers which are important for trusts.
“As interest rates went up, and with inflation going up, investors started reallocating and liquidating their positions, which provided a lot of sellside pressure on share prices”
Richard Lum
Victory Hill
The lack of depth on the buying side is also due to the trusts’ relative lack of liquidity. “The listed infrastructure market is becoming increasingly bifurcated between those companies that are of a sufficient scale and therefore have sufficient daily liquidity to be traded versus those that haven’t been able to build the scale in the short period of time they’ve been around,” says Hunt. TRIG and HICL – both managed by InfraRed Capital Partners – are among the largest trusts, at £2.6 billion and £2.7 billion, respectively.
With an excess of choice of funds, low liquidity and a disadvantaging cost disclosure regime, infrastructure trusts are a harder sell for a wealth manager. This has been accentuated by the consolidation of the wealth management industry, says Kent.
“Each of the large wealth managers has centralised teams to consider investments and prefer larger companies. We’ve been told that that number is moving from £300 million to £500 million or, in some cases, a billion pounds to be considered for their buy lists.”
Fourteen of the trusts are currently worth over £500 million, and only six exceed £1 billion. Plotting the size of the trusts against the discount shows how bigger trusts generally have a smaller discount. Bigger funds also tend to be more diversified, though Greencoat UK Wind is the exception as it qualifies as bigger while being narrowly focused. Talking to the fund managers, all agree that size does matter. What to do about it, however, is less straight forward.
Not easy to consolidate
“Size is an issue,” says Lum. “How do we get out of this? Consolidation!… Some strategies came out that weren’t fully thought through. And it’s good for investors to see that those fall away and the more sustainable and realistic strategies remain.”
There is definite interest on the buyer’s side. ORIT, trading at £450 million in market capitalisation, attempted to buy Aquila European Renewables (£211 million in market capitalisation) earlier this year, and TRIG and HICL are considering the options.
“Scale is important and greater scale would be advantageous. I think that’s a fair ambition that a number of the companies share. How we build that scale and over what time frame is to be debated,” says HICL’s Hunt.
The problem is the pricing. When trading at a discount shareholders might balk at accepting anything but an offer at NAV, particularly if the underlying asset is good quality debt. And what buying trust’s shareholders would accept to pay a premium on the share price to take over a smaller fund? So, unsurprisingly, consolidations have been few and far between.
Managers are also wary of diluting the original offering.
“ORIT’s approach to the board of the Aquila European Renewables vehicle is very much in line with that thinking that there is a benefit to investors of having greater scale,” Bird says. “I think the story that scale has benefits for investors will remain true, but for ORIT to look at any other vehicle [to take-over] it needs to make strategic sense.”
With little room for manoeuvre, managers reduce the revolving credit facility and buy back shares from cashflows to increase the share price. Some use inflows to slowly grow organically too. But, for the time being, managers are basically stuck with low-growth trusts, which is no one’s idea of fun.
“If there’s a frustration at the moment, it is that we haven’t made many new investments for the last 12 months… it does mean that we’ve passed on some attractive opportunities,” says GCP’s Kent.
Throwing in the towel by opting for a buy-out could provide new capital, but trusts were designed for another audience and are often quite diverse.
“For the private market, a more focused strategy is more sellable,” says Kent. “I think the next vehicle we launch will be a private market fund.”
Lum, too, is open to other options for future fund structures: “We already have a fund in the listed trust market. Let’s try something else now. Because the opportunity set is so compelling, and this can grow into a multibillion-dollar strategy.”
Two-plus is better than one
Single-asset trusts focused on either the battery storage, digital and hydrogen space have had more trouble than more diversified ones. The Hydrogen One Capital Growth rode the hydrogen hype at the launch and then struggled as worries over the asset class mounted.
On the digital side, there are two funds, one of which, Digital 9 Infrastructure, fell on an interest-rate-sharpened sword when a need to refinance £375 million of debt next year made shareholders back a wind down proposal. The second, Cordiant Digital, has seen its share price rise alongside the NAV, but the discount remains stubbornly well above 30 percent.
Battery storage-focused trusts are a chapter aside. Three are listed in London, all trading at a 45-plus percent discount and have dividends missed or cancelled following lower revenues. As ever more intermittent capacity is added to the grid, the cashflow figures could possibly pick up. Whether the share price follows suit remains to be seen.
Contagion from single-sector vehicles to the more diversified funds may be putting extra pressure on the latter, says Bird: “I have some sympathy with investors saying, well, are renewables next? But if you look at the renewables generation-focused funds, ORIT’s got over 80 percent of our revenues fixed for the next two years. We’ve got 70-odd percent fixed over the next 10 years… it’s a much more contracted revenue mix.”
For funds focused on PFI/PPP, it is a question of running out of road. Over 330 PFI projects will expire in the coming decade and new ones are rare, though the new UK government is reportedly considering a revival of the structure. Any change in environment will affect the mainstay trusts such as HICL, International Public Partnerships and BBGI Global Infrastructure the most.
Looking ahead, a new infrastructure vehicle going to initial public offering would be a surprise. And while we may see some consolidation, the expectation is that smaller trusts will simply opt to wind down over the coming years.
Unless, of course, the interest rate environment changes dramatically to bring lower-leveraged securities offering inflation-protected yield and growth opportunities back in vogue.