Phil Kent, adviser to GCP Infrastructure Investments Ltd, discusses infrastructure investment, emphasising the impact of high interest rates and inflation. A decline in rates could renew interest in infrastructure as a stable, long-term income source. Historically, infrastructure has provided inflation-linked returns, making the current inflation environment crucial. Infrastructure is capital-intensive, and cost efficiency is vital. A lower rate environment could reduce infrastructure costs and positively impact new developments. Hear more in the video below:
Outlook for the infrastructure sector
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What is the outlook for the sector over the next 6 months?
I think we're hopefully at the peak of the rate environment, and I think infrastructure has suffered during the period of higher rates. The fact that it was an alternative to fixed income, when fixed income wasn't delivering very much from traditional sources, bonds and gilts, meant that infrastructure was an attractive asset class as an alternative to that. During a higher rate environment on a relative basis, and that attractiveness has become less significant. So a reversal of that rate environment, we hope will lead people to relook at infrastructure as a long term, reliable source of predictable, stable income in portfolios. So I think the rate and macro environment is key to drive interest in infrastructure. I think the inflationary environment, I guess, linked to that is also one to watch. I think infrastructure has traditionally delivered inflation linked returns over the long term, and it generally has achieved that during the period of pretty high inflation over the last couple of years. So how the inflation environment changes, how that flows through to the economics of underlying projects, is also something to watch. I think, in general, the commitments that this country and others have made towards decarbonisation challenges like digitalisation aren't going away. And I would say that we haven't been investing sufficient amounts in new infrastructure in order to meet those challenges and that would be validated by comments made by entities such as the UK's Committee on climate change that point to significant underinvestment relative to the government's targets. I'd like to see that reverse. I hope the new government is a catalyst for that. I think critically, as part of that, there has to be an acceptance that new infrastructure is a capital intensive sector. Someone ultimately has to be responsible for paying for that and ultimately making sure it's delivered in the most cost efficient way possible across funding it, operating it, building it is going to be really important if we're, as we're about to embark on a significant capital investment programme across a number of different sectors. I think there's lots of challenges for the new government when they come in, but I think it's an exciting time to be investing in the sector.
Is infrastructure debt attractive today vs. other kinds of debt?
I think there's been a natural re rating of infrastructure debt. So infrastructure debt tends to be very long term fixed rate, or where it's invested in a project, it tends to be swapped at that project level. So the interest rate risk is minimal to the project itself. So during a period of higher rates on a relative basis, there has been a re rating in the infrastructure sector, and I think we've certainly seen that in the UK, listed space as well as over time, and lagged the private market valuations that we've seen as well. So on a relative basis, infrastructure has a job to do to reset itself. I think that creates some challenges, that being a very capital intensive sector, the funding costs are the key component of an infrastructure project. So the overall returns or the cost of provision of the infrastructure service is very sensitive to the rate environment. So I think a low end of the rate environment, and if indeed we are at the peak, as I think some suspect, that I think will have the dual impact of a re rating of infrastructure more generally as a long dated, relatively fixed rate investment, albeit with inflation linkage and some protection, particularly in the portfolios that we manage at Gravis. But also I think it will open up new infrastructure development in that it lowers the cost of that infrastructure provision, whether it's the effective energy cost or the effective cost of services that infrastructure will provide. Because of that high sensitivity to upfront capital investment.
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