What gives specialist sectors an advantage?

The hunt for income has shown no sign of slowing. Alternative assets in areas such as infrastructure, debt and property can offer a high level of income, and, being illiquid assets, they are particularly suited to being held in a closed-ended fund. Indeed, of the 49 investment companies yielding over 5%, 32 (65%) are from specialist sectors[1]. What gives these specialist sectors an advantage when it comes to yield? Why would investors consider these specialist sectors as part of their income portfolio?

 

Infrastructure investment

Infrastructure assets are the things that a society or economy needs to operate, and we are all involved in these assets as consumers, whether via our tax bills for healthcare and education or through our utility bills for energy. However, it is only relatively recently that a wider case has been made for infrastructure as a core investment class. Infrastructure investment attracts investors seeking long-term, reliable income. Firstly, this is because infrastructure assets are typically expensive and need to be capable of generating a predictable, long-term cash flow in order to justify the initial expenditure to get them built. Secondly, because the assets are so important to the society or economy that they serve, they will often have explicit or implicit governmental support.

Unprecedented stimulus

Fixed income has been the primary beneficiary of global central bank intervention since the credit crisis began in 2007/08. Since 2009, a combination of artificially low interest rates, forward guidance and outright asset purchase programmes have set the foundations for investors to reap the benefits of unprecedented stimulus. The European Central Bank is the latest incumbent to undertake a significant program of support which, as a side effect, will drive yields and credit spreads into historically tight levels. Even in the US, where quantitative easing has finished and rates are expected to rise later this year, the Fed remain accommodative and the environment expected to continue to be supportive for credit over the medium term. Therefore, investment in credit, particularly where some degree of illiquidity premium can be sourced, is the ideal place for the longer-term investor to be invested.

Balanced portfolio

The advantages of holding healthcare property as an ‘alternative’ within a portfolio are twofold. Firstly, with favourable underlying population dynamics, demand for investment in the sector is high. Approximately 15% of over 85-year-olds are expected to make use of residential care of one form or another, and to meet this demand, the UK’s ageing care home stock needs to be substantially upgraded and new facilities built. Secondly, there is a real income advantage. With long leases on properties, often up to 30 years, stable, long-term and inflation-linked income paid in the form of a 6% dividend paid quarterly can be created.

Commercial real estate can form part of a balanced portfolio, as it provides diversification and a combination of equity and bond-like characteristics. At present, the IPD index has a market income yield of 5.5% for the UK, and by having a balanced portfolio, it is possible to provide a sustainable and growing income yield to investors. The UK commercial real estate market offers investors a mix of exposure to upwards-only open market rent reviews (good at times in the economic cycle such as now where there is growth in market rents) and also indexed reviews to either a fixed percentage or RPI.

Improved understanding

The listed infrastructure sector was initially focused on PPP/PFI and economic infrastructure, but in recent years, the sector has expanded to also include renewables investment companies and infrastructure debt funds. While the return, risk profiles and investment policies vary between the companies in the sector, the group has delivered stable, predictable dividend income to investors, while also delivering low price volatility and low correlation with other asset classes. The sector has also benefited from improved understanding amongst investors of the asset class and strong performance relative to broader markets. The London listed infrastructure sector has matured to the point where it now warrants inclusion in most well diversified portfolios.