Here, rather than revenues being contractually defined and government-backed, they move to being determined by demand, which increases their correlation with economic growth.
Companies in the sector span this risk scale to varying degrees. However, with the goal of reducing correlation with other economically exposed assets, we prefer those towards the lower end of the risk scale.
Labour political risk and nationalisation
Mr Hammond’s comment in his Budget speech on the cost of breaking existing PFI contracts was a reminder of the minefield in implementing the policy suggested by Mr McDonnell. We believe it would be very hard and unlikely for a Labour government to be able to follow through in full on those promises.
For the listed infrastructure investment companies we own, the pain of a Carillion break-up and the subsequent costs borne by the private sector and the shareholders of companies in the infrastructure investment company sector – ourselves included, was a reminder that risk transfer did exist.
In other words, it was a reminder that backing government infrastructure projects is not necessarily a win/win for the private sector and there needs to be a risk/reward pay-off.
Were Mr McDonnell to have had his way immediately following the speech, the costs for dealing with the break-up of Carillion would have been a cost for the public purse.
Supply chain
The Carillion debacle is a reminder of the potential impact of disruption from other contractors that collapse into administration.
Other contractors similar to Carillion have issued profit warnings in the past year, but the indication is it is not systemic.
Looking underneath the hood of infrastructure companies and their exposure to various contractors can indicate how diversified they are in this regard.
Rising interest rates
Rising interest rates potentially impact infrastructure companies through two main sources: one is the impact on the cost of financing, given the debt embedded in these companies, and the other is through the demand side for infrastructure investment companies, which could wane as interest rates rise and the need for income funds subsequently recedes.
The counter to this is that higher rates are already partially priced into the discount rates used to value the assets. The longer-term discount rates used over the past 10 years is in the 7 to 8.5 per cent range, so despite the much lower base rates, discount rates are pretty much sitting there already.
Rising interest rates are a potential risk, but not one the sector cannot weather.
So what about the future? The government had already changed PFI into PF2 in 2012, but only six new projects have so far been signed under this regime, arguably because it has proved too complex.
