Share prices have remained under pressure year to date in 2024 across listed real assets. Frankly, it’s been a difficult time to be invested in the sector over the last 24 months. We too have felt the pain being co-invested in our strategies alongside investors. Fundamental analysis of underlying portfolio companies appears to have been completely disregarded by the market and macro factors have driven a dash to the exit. At the risk of sounding like a broken record, we believe asset allocation rotations, changing expectations of short-term interest rates and, in the UK, industry consolidation and regulatory own goals regarding cost disclosures have driven greater downside in share prices than warranted by fundamentals. This has resulted in deep discounts in listed markets to fair value, either to a published companies net asset values (“NAVs”) or comparable private mark transactions. Looking forward, there is growing reason to that most headwinds are now behind us.

As volatility has persisted investors may be questioning next steps with paper-losses incurred. It would be remiss of us not to remind investors of what they own in the Fund. We invest in listed businesses that own cash generative physical assets, such as schools, hospitals and wind farms. These assets are critical for economies, and we all rely on them for the smooth functioning of society. Governments and corporates enter long dated contracts to use the assets to deliver goods or services while the investor pays for the build-out and maintenance of these large-scale projects. For the upfront investment, the investor typically earns a regulated or contractual, often inflation-linked, cash flow from high quality counterparties. “Availability-based” cash flows which many projects earn, face limited economic sensitivity and benefit from contractual escalators driving steady growth over time. As such, infrastructure assets have historically delivered stable and predictable total returns through various interest rate cycles.

Negative sentiment has weighed on listed infrastructure companies. We think there is a relatively simple reason for this. In an economic environment where capital is more scarce and more costly, investors are trying to establish whether infrastructure companies generate reliable or growing earnings, and where asset valuations should be marked to reflect a required return? With returns available in other asset class, primarily fixed income, investors have not had to stick around to figure out the answer to this question. This capital flight has depressed listed infrastructure valuations with the current weighted average discount to Net Asset Value (“NAV”) of the Fund standing at c. 25%. This is amongst the widest levels in history of the Fund, and we believe more than accounts for the costs of running the companies and the higher interest rate environment. Our reasons for optimism going forward are driven by the following fundamental and technical factors:

 

1. Companies have adapted well to the new world

Rather than clinging on to the pleasant environment brought by a low cost of capital world where equity markets were wide open, management teams have had to work hard in recent months to establish a go-forward strategy which takes a realistic look at the prevailing economic situation. We believe management teams have reacted well in most cases, taking a strong look at managing debt burdens and considering asset recycling programs while largely pausing new investment activity and repositioning towards higher conviction opportunities.

2. Proof points of NAVs highlight the value and increase the possibility of M&A

Companies like HICL Infrastructure PLC, Octopus Renewables and Foresight Solar Fund have demonstrated their ability to recycle assets at material premiums to carrying value. Considering the dislocation across the sector, UK listed infrastructure companies screen attractive relative to private markets and the valuation gap should eventually close as public markets re-rate with easing interest rates or takeouts occur. The Fund has already benefited from M&A activity in the sector, and we expect this to remain a theme over the rest of the year as market participants seek to deploy capital into a sector that offers attractive inflation linked income streams and defensive growth characteristics.

3. Companies have proven earnings remain resilient

As the latest string of NAVs and quarterly earnings comes to an end, we continue to see portfolios holdings generating defensive cash flows. For example, 3i Infrastructure announced in its most recent trading update that portfolio companies are performing ahead of expectations and benefitting from the tailwinds prevalent in the Fund’s core sectors. The investment opportunity across areas such as core infrastructure, data centres and renewable energy remains as strong as ever and the investment delivery models are going to continue to adapt as private capital is required in the sector. As a result of the inherent inflation linkage, asset management opportunities and strong earnings profile, we believe portfolio companies can continue to drive mid-to-high-single digits earnings and dividend growth. Combined with a starting yield of c. 5.8%, the real and defensive return prospects of the Fund remain attractive.

4. Activism is increasing, a sure sign of capital markets identifying valuation inefficiencies.

We note an increasing number of foreign and activist investors appearing on the shareholder registers of UK listed infrastructure businesses. This has been coupled with relatively increased volumes and block trades in the shares of certain companies, suggesting there is a price where buyers are willing to step in. Activist investors can often provide a valuable wake up call to shareholders, boards, and management teams to kick start changes necessary to deliver better outcomes for all shareholders. Corporate actions like strategy reviews, mergers, wind-downs and management changes were rarely considered in the sector over the previous decade. Today they are firmly on the table and will lead to a healthier eco-system with stronger companies.

5. The barriers to investing in the sector may be relaxing

The UK’s abnormal synthetic cost disclosure regime has created a negative incentive structure that resulted in capital leaving the sector as cost conscious investors sought cheaper portfolio solutions. The ongoing parliamentary readings of Baroness Altmann’s Private Members Bill and increasing support from industry and politicians strengthens our conviction of favourable legislation eventually emerging. The reduction in reported synthetic costs should reduce barriers to investment and potentially open the door for domestic pension funds to gain exposure to strategically important sectors within the UK economy, creating a new source of demand for shares.

 

Pessimism in the listed sector appears to be at a near-term high and as a result, valuations are at or near all-time lows. Considering forward-looking returns, FCM views the sector to currently be priced amongst the most attractively valued levels relative to its own history. There remain several near-term technical and fundamental catalysts that can unlock value and, in the meantime, we remain comforted by the fundamental performance of portfolio companies. We remain vigilant for new opportunities and seek to position the Fund in the best possible position to benefit as factors above materialise. FCM thank investors for their continued support and patience through these volatile times.