Rising bond yields are putting pressure on infrastructure and property investment trusts, as returns from “risk-free” development market bonds provide competition for strategies whose aim is to generate a steady income for shareholders.
With investment grade corporate bonds yielding about 6.5%, and UK government bonds offering investors 5% in shorter maturity debt, investors are no longer so keen to own bond alternatives, such as infrastructure trusts.
Over the past month, the 10-year gilt yield has risen from 4.25% to 4.7%, while the 10-year US government bond yield has moved from 3.87% to 4.29%.
Higher interest rates also affect the valuations of infrastructure assets because this greater “discount rate”, which is what the future cash flows of an asset are measured against, leads to a lower valuation placed on an investment.
Another concern is that debt costs for these investment trusts are rising. They use borrowing to purchase new assets, but the cost of acquisition has now risen substantially.
Rising yields are a response to stronger than expected economic data, such as wage growth and low unemployment, which has caused investors to bet that interest rates will be higher for longer.
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Inflation figures last week in Britain showed that while headline inflation continued to fall, there is not much room for the Bank of England to be complacent as core inflation was unchanged.
CPI inflation came in at 6.8% for the year to July, which was above the 6.7% that economists had forecasted.
Core inflation, which excludes volatile food and energy prices, was stuck at 6.9% and service prices increased at an annual rate of 7.4%, compared with 7.2% in June.
Wage data this week also showed that inflation could become embedded, with private sector salaries, excluding bonuses, rising 7.8% on an annual basis for the three months to June.
Markets now point to rates peaking at about 6% in Britain, and economists think they will not be cut before mid-2024.
In response to rising yields, the Association of Investment Companies (AIC) infrastructure sector dropped 6% on a total return basis over the past month, including a 4% weekly drop. The Renewable Energy Infrastructure sector fell 4.2% over the month and 2.6% over the week.
Since 2022, the average infrastructure trust is now down 27% on a total return basis, while renewable energy infrastructure trusts are off 14% on average.
Property investment trusts also fell, with the UK Logistics and UK Residential sectors dropping 4% in a week, and the UK Commercial Property sector falling 3%. Since 2022, UK Logistics trusts are down 43% in average, while residential trusts are off 36% and commercial property trusts are down 24%.
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The biggest losers over this month in the infrastructure sector were Cordiant Digital Infrastructure (13.6% drop), GCP Infrastructure Investment (8.9% drop), Pantheon Infrastructure (8.6% drop) and Digital 9 Infrastructure (8.6% drop).
In last week’s Discount Delver list, half the featured trusts belonged to either the AIC’s Infrastructure or Renewable Energy Infrastructure lists. Two property trusts featured: Custodian Property Income REIT (now on a 20% discount) and Supermarket Income REIT (now on a 24% discount).
Bargain hunters may be tempted by large discounts and yields in the infrastructure sector. For example, Triple Point Energy Transition is on a 30% discount and yields 9.3%, JLEN Environmental Assets is on a 21% discount and yields 7.75%, Digital 9 Infrastructure is on a 54% discount and yields 11.8%, and GCP Infrastructure Investments is on a 29.8% discount and yields 9.8%.
Balanced Commercial Property also makes the list. It is on a 44% discount and yields 7.4%.
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