HICL Infrastructure 29 October 2019

HICL offers investors an exposure to over 100 institutional quality, lower-risk core infrastructure assets. The primary aim is to provide a robust and steady income stream, with low correlation to changes in GDP or equity markets. HICL’s portfolio has been built up over the past thirteen years, with the manager’s aim being to pay a sustainable dividend, as well as to diversify and extend the income stream as much as possible.

The manager invests in lower-risk, core infrastructure assets with good correlation to inflation over the long term, as well as longevity. Whether investing new capital or reshaping the existing portfolio, the manager seeks to continually improve and optimise the portfolio’s overall characteristics. Over the past year or two, they have been paying particular attention to the portfolio composition. During the last financial year, the manager took advantage of favourable market conditions to make two strategic disposals (realising a total of £148m) and reinvesting £167m in six assets.

The manager has been successfully extending the average portfolio duration over time, and in the last financial year managed to keep the duration level at 29.5 years, despite a year having elapsed. Over that period the manager reviewed a number of investment opportunities with the objective of improving total returns, portfolio yield, cash flow longevity, and inflation correlation. We understand that during the last year InfraRed looked at 65 deals which fit HICL’s investment policy; of these they conducted detailed due diligence on 11 deals on HICL’s behalf, which eventually resulted in five investments being made to deploy the capital resulting from the two strategic disposals.

On a total return basis, HICL has outperformed UK equities since its IPO, delivering a total return of 9.4% p.a. to 31 March 2019, against 6.0% for the FTSE All Share. This strong track record applies even over shorter time frames, with the company having outperformed UK equities over both five years and 12 months. HICL continues to deliver consistent returns with low volatility.

The portfolio’s discount rate, less HICL’s ongoing costs, gives an idea of expected returns going forward. The weighted average discount rate (as at 31 March 2019) was 7.2%, and ongoing costs last estimated as 1.08% pa. Any deviation from this expected return could be a result of either ‘alpha’ delivered by the manager (upside), portfolio risks such as that posed by Carillion (downside), or changes to underlying valuation assumptions (the company is most exposed to changes in the discount rate and inflation assumptions). The depth of resource and breadth of expertise in the HICL management team helped to minimise the impact of Carillion’s failure, and the HICL board has drawn a line under that episode, with a final estimate of the total costs attributable to Carillion coming in at £33m (1.1% of NAV).

The 13-year history of HICL illustrates why infrastructure investing has proven so attractive for long-term investors, both in the consistency of returns and the lack of correlation to equity markets. Despite the manager’s preference for investments at what they view as the lower end of the risk spectrum, the company has handsomely outperformed the FTSE All Share since its IPO, on both a NAV and share price basis, but also over shorter time periods such as the past five years and the last 12 months.

Over the short term, a number of small uncertainties have weighed on HICL’s share price. Political pressure appears to have abated somewhat, and the Carillion insolvency is now firmly behind it, with only a minimal negative effect (1.1% of NAV). The one remaining uncertainty (Affinity Water) has been quantified by the board and looks likely to be resolved very soon (by the end of December 2019). The current share price premium of around 8% is in line with the average seen over a longer timeframe.

HICL remains the pre-eminent vehicle for investors to get access to a diversified portfolio of high quality, lower-risk core infrastructure assets. The dividend target for the current year is equivalent to a dividend yield of 4.8%, which looks highly attractive given the robust levels of income that HICL has delivered in the past and looks set to deliver into the future.