As with any investment, your capital is at risk and any income is not guaranteed.
Are you tempted by an asset yielding more than 5 per cent, with inflation-linked growth in revenue and profits over 20 years?
That’s what’s on offer from many UK ‘real assets’: property and infrastructure companies. Both have been challenging to invest in lately. They’ve grown in size and popularity over the decade but post-pandemic returns have been disappointing.
It’s perhaps not surprising. Few expected UK inflation to peak at over 11 per cent in 2022 or interest rates to rise so sharply. An attractive feature of real assets companies is the long-dated, almost bond-like nature of their income streams. However, as interest rates soared, those dependable cash flows faced competition. Investors ditched them for risk-free cash returns, which rose to their highest level since before the Global Financial Crisis (GFC) of 2008.
This volatility created compelling opportunities for those with a long time horizon. As equity markets continue to hit record highs, the case for diversification is clear.
Our Monthly Income Fund aims to give clients an attractive income stream that grows with inflation, supported by capital that maintains its real value. The typically inflation-linked revenues of property and infrastructure companies make them ideal candidates.
We have increased our real assets allocation in the past year. And although we have no domestic bias, we’ve added to UK property and infrastructure. Why?
Take property valuations. The average real estate investment trust (REIT) in the FTSE 350 index trades at a 26 per cent discount to net asset value. For context, the average discount since the GFC is just 10 per cent. Discounts of this size are rare, usually seen only in periods of extreme market stress.
Of course, there may be value traps among those seemingly cheap assets. The advantage of buying individual REITs is that we can focus on specialised property companies with scarce assets. Those assets range from logistics warehouses and datacentres to primary healthcare and student accommodation.
Take Assura, whose healthcare assets – mainly GP surgeries – serve more than six million patients in the UK and Ireland. There is growing consensus that the NHS needs to invest more in primary care to reduce waiting lists. This should support rental growth in Assura’s core business. It has also diversified into the fast-growing private healthcare market in the UK, developing new facilities for the largest operators. These tailwinds should support Assura’s high dividend and underpin attractive total returns, which is why we’ve added to our holding.
Our newest property holding is Grainger, currently the UK’s largest private residential landlord. The UK’s acute shortage of homes for rent has been compounded by tax and regulatory changes, causing small, buy-to-let landlords to sell up. Institutional landlords are filling the gap, providing purpose-built and professionally managed accommodation. Grainger’s expansion into this market should improve financial returns, justifying a higher share price.
Valuations in infrastructure are also appealing, but there are other catalysts for higher returns. For all its perceived shortcomings Labour’s ‘growth’ drive promises to speed up decisions on infrastructure megaprojects.
With tight public finances, the UK must attract private capital to complete these projects by enabling companies to make profits and liberalising planning. Government and regulators are now aligning on tough choices to encourage investment. The Chancellor’s fast-tracking of a third runway at Heathrow – first discussed over 20 years ago – is a sign of intent.
Derwent dam © Severn Trent
One struggling area of UK infrastructure is the water network. The water companies and their regulator, Ofwat, recently announced £104bn investment until 2030, a quadrupling of current spending. The regulator improved financing conditions and incentives for investors – a sign of adapting to a higher interest rate world.
As an investor, what’s not to like? Well, along with improved potential benefits from achieving targets come increased penalties for failure. As with property, careful stock selection is essential to ensure we only invest in companies stepping up to this challenge.
Company culture and the quality and ambition of management matter when understanding these regulated utilities. Severn Trent, under Liv Garfield’s leadership, was one of only two (out of 17) water companies to receive a business plan rated ‘outstanding’ by Ofwat last December. The Environmental Agency has awarded it a top environmental performance rating for five consecutive years. Severn Trent enjoys the highest performance-based bonuses among its peers, supporting its growing dividends. As long-term investors, we can look through the noise and negative sentiment surrounding the UK water industry and take a position in a leader like Severn Trent while steering clear of most others.
The breadth of opportunities across listed UK property and infrastructure companies is wider than it has been for some time. While the Monthly Income Fund’s exposure to these assets has weighed on its short-term capital performance, it’s ideally placed to benefit from a recovery in investor sentiment and share prices. In the meantime, we are being ‘paid to wait’ with positive real income yields.
Risk factors
This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA).
Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.
- Market values for illiquid securities which are difficult to trade, or value less frequently than the Fund, such as holdings in weekly or monthly dealt funds, may not be readily available. There can be no assurance that any value assigned to them will reflect the price the Fund might receive upon their sale. In certain circumstances it can be difficult to buy or sell the Fund's holdings and even small purchases or sales can cause their prices to move significantly, affecting the value of the Fund and the price of shares in the Fund.
- Investments may be made directly in hedge funds or, through specific investment vehicles into property, infrastructure and commodities. Returns from these investments are sensitive to various factors which may include interest and exchange rates, economic growth prospects and inflation, the occurrence of natural disasters, and the cost and availability of gearing (debt finance).
- The Fund has exposure to foreign currencies and changes in the rates of exchange will cause the value of any investment, and income from it, to fall as well as rise and you may not get back the amount invested.
- The Fund's share price can be volatile due to movements in the prices of the underlying holdings and the basis on which the Fund is priced.
- The Fund invests according to sustainable and responsible investment criteria which means it cannot invest in certain sectors and companies. The universe of available investments will be more limited than other funds that do not apply such criteria/ exclusions, therefore the Fund may have different returns than a fund which has no such restrictions.
Further details of the risks associated with investing in the Fund can be found in the Key Investor Information Document or the Prospectus, copies of which are available at bailliegifford.com.
141412 10053236
