Infrastructure, renewable energy and property are the sectors that offer the most scope for gains, should interest rates start to fall, according to a recent report from the Association of Investment Companies (AIC).

Canadian, European, Swedish and Swiss central banks have already cut interest rates this year, and it is expected other economies will follow suit in the coming months, as numerous measures of inflation continue to ease.

In a release issued in July, the AIC pointed out that some investment trusts are more sensitive to interest rates than others and stated that it had “asked analysts* and wealth managers for their views on the sectors and individual investment trusts they think investors should consider for a scenario of falling rates.”**

Annabel Brodie-Smith, Communications Director of the AIC, said: “Many of the alternative investment trust sectors have suffered due to higher interest rates and a shift towards fixed income. Analysts are predicting that investment trusts in sectors like property, private equity and infrastructure may benefit from interest rate cuts. These trusts are trading on historically wide discounts, which could present a buying opportunity.”

“In our view, investment trusts in the property sector are well placed to benefit from interest rate cuts in the UK,” commented Emma Bird, Head of Investment Trust Research at Winterflood. “Underlying real estate valuations were hit in the rising interest rate environment, as demand for property from debt-funded buyers diminished. Property values across most sub-sectors now appear to be stabilising, but share price discounts to NAV remain at very wide levels. As the path of future interest rate cuts becomes clearer, property funds could see both asset prices and share prices improving as investor sentiment turns more positive.”

This is a view shared by Matt Norris, investment adviser of the VT Gravis UK Listed Property Fund, who says there is a danger that investors could miss an initial bounce in the sector when sentiment changes. “The inflection point could come when the Bank of England announces its first rate cut,” he said. “At this point, the trickle of investment could easily turn into a flood.”

You can read more about this here: Gravis | Don’t miss the REIT bounce (graviscapital.com)

“We view the infrastructure investment trust sector as well placed to benefit from interest rate cuts,” continued Emma Bird. “Over 2023, the infrastructure peer group was amongst the worst performers in the investment trust universe as rising gilt yields reduced its appeal. As a result, the sector is trading at a historically wide weighted average discount of 22.3% versus a 1.8% average premium over the last five years. Hence, given the long duration and resilient nature of the asset class, we would expect the sector to be a key outperformer as interest rate cuts materialise.”

Iain Scouller, Analyst at Stifel, agrees: “Alternatives, such as private equity and infrastructure, should benefit across the board,” he said. “They have been impacted as a result of higher rates making fixed income relatively more attractive. Those trusts offering long duration income especially should see some additional support. Many funds have debt on floating rates and so there should also be a direct benefit from lower interest costs.”

“We think the infrastructure and renewables sectors look very well placed to outperform,” added Ben Newell, Investment Companies Analyst at Investec. “In the main, underlying assets and projects continue to perform well operationally and we believe that the defensive characteristics that listed infrastructure exhibits, namely the relatively high initial yield and the ability to protect against inflation over the long term, remain attractive. As the direction of future interest rates becomes clearer, the disconnect between share prices and underlying valuations should reduce.”

Shayan Ratnasingam, senior research analyst at Gravis, recently highlighted the plans that the new government has in place for infrastructure and renewables. You can read more about these and how investors can take advantage of the proposals here: Gravis | What do we know of the new government’s plans for UK… (graviscapital.com)

“We think infrastructure and renewables, given their assets with long duration cash flows, will see improving valuations as rates come down,” commented Matt Hose, Investment Company Analyst at Jefferies, said. “It will be the funds in these sectors with relatively lower discount rates that benefit in particular, because there is less of a risk premium buffer embedded in their discount rates. That means that lower interest rates will directly translate into lower discount rates for those trusts, increasing published NAVs.”

Among the trusts Matt Hose recommended in the report are HICL Infrastructure, International Public Partnerships, Foresight Solar Fund, and JLEN Environmental Assets Group, which are all top ten holdings in the VT Gravis UK Infrastructure Income Fund***.

He also recommends Bluefield Solar Income Fund, a top ten holding in the VT Gravis Clean Energy Income Fund***, and GCP Infrastructure Investments.

One of the recommended REITs from Dan Boardman-Weston, Chief Executive of BRI Wealth Management, is Urban Logistics REIT, while Emma Bird favoured Impact Healthcare REIT – both are top ten holdings in VT Gravis UK Listed Property Fund***.

“One of our favoured property investment trusts at present is Impact Healthcare REIT, which invests in UK care homes,” Emma said. “This fund is currently trading at a 27% discount to its 31 March 2024 NAV, which we think offers considerable value, and believe there is scope for a notable re-rating when interest rate cuts are announced. In addition, this fund has seen its underlying asset valuations hold up considerably better than many other property investment trusts, supported by the contractual, inflation-linked uplifts in its rents, which we expect to continue to support earnings and dividend growth going forward. Impact Healthcare REIT offers an attractive 8.2% prospective dividend yield, with its dividend fully covered by earnings. It has increased its dividend every year since launch in 2017, and we view this progressive dividend policy as a key advantage of the fund, which should continue to differentiate it in a ‘higher for longer’ interest rate environment.”

Meanwhile, among Ben Newell’s recommendations were The Renewables Infrastructure Group, and Greencoat UK Wind, top ten holdings in VT Gravis Clean Energy Income, and 3i Infrastructure, another top ten holding in VT Gravis UK Infrastructure Income.

*Please be aware that analysts may recommend trusts that are corporate broking clients of the firms they work for. The discounts in analysts’ quotes were correct at time of submission. Please see theaic.co.uk for up-to-date information.

** Which sectors and trusts could benefit from lower rates? | The AIC

***as at 30 June 2024

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