The VT Gravis UK Infrastructure Income Fund recently turned 8 in January. Will Argent, Shayan Ratnasingam, and Cameron Gardner answer questions surrounding recession, inflation, yields, M&A, cost disclosure and the catalyst for share price rerating.

A short video of the discussion can be found below along with a transcript, modified for your reading pleasure.

If the economic situation were to worsen more than expected, that is going to filter through to more aggressive assumptions around perhaps Bank of England rate cuts, how swiftly those happen, and how deep they may be to try and stimulate the economy. On the other side, as hopefully we articulate time and time again, the resilience of the cash flows of the underlying companies to which we’re exposed, a key attraction of the infrastructure space, those contracted cash flows, and by virtue of the critical nature of the services those projects and assets are providing, we’d expect those cash flows to prove resilient. The life of the Fund and the life of the UK infrastructure sector is now building out such that it’s been through periods like this and been able to deliver. I think for our strategy, versus a number of other asset classes, you would see that as being a positive situation and you’d be hopeful that the Fund would perform well for those reasons I mentioned, and also the fact that it could act as a bit of a safe harbour, people looking to de-risk.

We have exposure to both and INPP is not quite in the top 10, as we saw earlier, we brought INPP more and more of late, the last year to 18 months, based on the valuation opportunity. Historically, we saw better valuations and HICL being more attractive. I do see them as quite similar exposures, but a lot of that has been based around yield valuation, rather than a really strong view on the underlying portfolios, because we like them both but they’re not hugely dissimilar.

I guess when it comes to asset valuations, we were talking about how we can see them as being quite resilient. On the one hand, you’ve had the headwind provided by higher discount rates factored into asset valuations, but on the flip side, countering that, the stronger inflationary environment, and remember, this is all relative to what the companies have assumed. You may have a longer-term inflation assumption of 2-3%, and in periods where you’re getting like we’ve just had – very strong inflation relative to those sorts of levels, of course that rebases cash flows higher and so has been a key offsetting factor to those higher discount rates. It’s a key part of why we’ve seen quite stable net asset values. That’s where you see it coming through in the asset valuation and of course, inflating cash flows are part of the drivers to progressive dividends as well over time.

I would think that inflation is going to track lower from the from the macroeconomists out there. I think you’re talking probably 300bps plus. It is tough to forecast but I think it’s attractive on a real view.

That 300 has been proven or historically tracked at that level.

Well, certainly relative to longer-dated gilts. Thinking about where inflation might be in a couple of years and where the Fund is at the moment on a yield basis – 300, maybe even edging up towards 400 I think.

I would say, from our perspective, we have seen the synthetic OCF, so that’s the requirement to show the underlying OCF of the investments which we hold within the Fund shown in our OCF figure. The requirement for that is a headwind for investors in the space, both in our Fund and, in the broader listed infrastructure sector. At the beginning of the year, we published new KIIDs, which revert to the cash OCF figure. That continues to be what we charge. At the moment, there’s a lot of work going on, Bill MacLeod, from our side has been working with several other parties to try and help explain the issues there. I unfortunately cannot give a timeline on when we will be able to revert to just using that original OCF figure, but just to say that this is in motion and we’re hoping to have relatively good news in the near-term.

We sit here comfortable and confident in the ability of the broader portfolio to continue to deliver that resilient cash flow and income generation. The underlying key attractions and characteristics of this space, resilient income is up there. I think you should have confidence in the yield of the Fund and its ability to generate real yield, certainly from where we are today, in terms of the absolute yield on the portfolio and where inflation is right now, let alone where it’s potentially heading to.

We invest in companies listed in the UK and there are companies to which we’re exposed to who do have assets in Northern Ireland.

We have exposure via PHP, which is primary healthcare, Assura, which is healthcare also has some assets there. We also have exposure to some of the renewables, but going forward we will definitely enlarge the map in terms of exposure.

I think broadly speaking, there is quite compelling value in this space. I wouldn’t be surprised to see more M&A, whether that’s mergers of listed vehicles, whether it’s private equity, or other outside capital coming in and looking at acquiring companies. We’ve seen that in our direct equity positions. Just going back to the slide that Shayan had up earlier, we’ve seen corporate M&A from a top level, corporate level takeovers, but we’ve also seen deal activity at a lower level, underlying portfolios of projects being sold and brought. I expect the current environment to provide more of that in this space. To date, we’ve seen a bit in the specialised REITs area, Tritax and UKCM more recently. We have exposure to Tritax Big Box, so that’s going to scale up with that deal. Underlying sales of portfolios or assets, we’re seeing transactions occur, which is very useful because a number of listed infrastructure companies are looking to delever or certainly pay down their floating rate debt exposures – often they have through revolving credit facilities, so you hope for an active market there. Shayan mentioned Smart Metering Systems, which was subject to takeover. It’s working its way through. We actually decided to exit the position at the beginning of February, marginally below the takeover price, but we wanted to release that capital. We’ve also had another operating company, Renewi, which is a recycling and circular economy play in the portfolio – that received a takeover offer last year but was rejected by the Board at the time. We haven’t seen anything really in our closed end space and to touch on Aquila European Renewables, its not held in this portfolio but I think that’s been subject to an approach or conversations with other listed renewables, Octopus Renewables, which again is another name not held in this Fund.

I don’t think it will be a case of the first rate cut we see in the UK and then the sector moves. It will be a bit more like Q4 last year. A great confidence in those rate cuts coming and tailing off in longer-dated reference yields. I think those are key catalysts for the sector from a fundamental level. Then, there is other outside stuff which has been mentioned, like synthetic OCFs are not helpful. It would be great if a UK PLC could capture bid, by that I mean the FTSE250 and smaller end of the market, where a lot of these closed end companies are caught in basket trades of ETF trackers. The macro environment is key.

We don’t have an overarching figure for the portfolio. We keenly monitor company by company. On the one hand, we’re quite comfortable with the project level debt that many infrastructure companies have. These are long-dated fixed rate debt that amortise over the contracted life of an asset. Then you’ve got the Fund level debt, and that’s where it’ll typically be more expensive floating rate revolving credit facilities. As I mentioned, we know companies are looking to sell and divest assets to help that deleverage and to make sure that they don’t get into big financing issues. That refinancing becomes very pressurised, per the question. We’ve seen some divestments happen, whether it’s in the social space, INPP, HICL, have sold assets recently. We’ve seen some in the renewable space. I think we’re likely to see more news in this front, and this speaks to the broader transactions and M&A going on. I would imagine we’re going to see a bit more in that space over the coming months. A key part of that is companies’ focus and keenness to manage those gearing levels. It is something we’re acutely aware of and monitoring.

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