• Following years of outflows from UK equity funds across the market cap and sector spectrum, the attractiveness of domestic public market valuations is becoming too hard to ignore for investors with a long-term focus.
• A renewed commitment from the new UK government towards infrastructure investment, decarbonisation and energy security ensures a runway for accretive investment opportunities for infrastructure companies.
• With the evolving macro backdrop, bottom-up fundamental prospects of the sector and historically low valuations, investors should not overlook the attractive risk-adjusted return potential from the UK infrastructure sector.

 

Looking back
We last wrote to investors of the Foresight UK Infrastructure Income Fund (“FIIF”) in Q1 2024¹ and noted that “pessimism in the listed [infrastructure] sector appears to be at a near-term high and as a result, valuations are at or near all-time lows. Considering forward-looking returns, Foresight Capital Management (“FCM”) views the sector to currently be priced amongst the most attractively valued levels relative to its own history. There remain several near-term technical and fundamental catalysts that can unlock value and, in the meantime, we remain comforted by the fundamental performance of portfolio companies.” Following such bold statements, it is worth taking stock of where we currently stand and providing an update on the outlook.  

Following years of outflows from passive vehicles and actively managed UK funds across the market cap and sector spectrum, light may be appearing at the end of the proverbial tunnel. A recently published FT article² reported the attractive relative valuation of the UK equities and noted that large investment houses are becoming increasingly positive on the region. Whether this will lead to the return of large-scale flows is yet to be seen, however it is increasingly evident that the pessimism towards UK Plc seems to be unwinding. As investors consider asset allocation decisions following years of momentum and narrow leadership of the US and technology/AI companies, the attractiveness of UK equity and infrastructure sector valuations are becoming too hard to ignore for investors with a long-term focus. 

Since we last wrote to investors, catalysts for the valuation disconnect to reverse across holdings in FIIF are increasingly stacking up. Fundamentals remain strong with companies continuing to deliver on capital allocation plans. Over 70% of portfolio companies have sold assets above book value at an average premium to Net Asset Value (“NAV”) of c.15% over the last 12 months³, a theme that is expected to continue and further broaden across the portfolio. Furthermore, all the top 10 companies in the portfolio are also conducting share buybacks or are about to commence return of capital to shareholders. In the background, asset performance and cash flow generation remain robust, supporting healthy dividend growth going forward. We have welcomed prudent capital allocation decisions being undertaken by portfolio companies and expect it to be value and ratings accretive over the medium term.

 

The renewed commitment

From a policy perspective, the incoming Labour government has made strong commitments towards delivering healthcare, decarbonisation and energy security objectives while seeking business and private capital support. Initial policy decisions are much welcomed by the investor community following the previous government’s miss-steps however, fiscal prudence will be judged at the budget expected at the end of October. What is clear is that the new Labour government is showing a renewed sense of commitment towards industrial policy and is looking at supportive measures to crowd-in private sector investment to boost economic growth and address the country’s infrastructure needs.

A good example is the creation of the National Wealth Fund (“NWF”) which has £7.3bn of public capital ear-marked for high-risk investments that support the UK’s transition to a low carbon economy⁴. The initial investment priorities for NWF will be driven by an investment mandate allowing for greater risk-taking in nascent technologies across green steel, green hydrogen, industrial decarbonisation, gigafactories and ports. The focus on these sectors will support emissions reduction across Transport, Industry and Electricity Supply and more broadly support the eco-system required for large-scale infrastructure projects. When combined with Chancellor Reeves’ ambitions of reforming the UK’s pension model⁵ and support for innovative financing models for large-scale projects⁶, the wheels of mobilising capital and policy are being put into motion. 

For the renewables sector specifically the new Labour government has also made strong commitments to support the continued build-out of clean energy generation capacity to ensure energy independence and lower household bills⁷. This includes the £8.3bn of public funding for GB Energy to roll out 20-30GW of offshore wind projects and to accelerate nuclear projects, removal of bans against onshore wind projects and an increase in funding for the next auction round of clean energy development projects by 50% to £1.56bn. The policy support for renewable generation development has direct implications for portfolio companies who are providers of capital in the sector, and which facilitate developer balance sheets. These developer vendors can subsequently build more projects in the sector and drive energy independence for the nation while enabling lower bills for households through a lower cost of generation.  

 

Looking ahead

As we roll through the second half of 2024, many will be surprised with how events have transpired versus expectations at the start of the year. Just over the last couple of weeks we have seen a dovish monetary policy tone from the Fed, as well as the Bank of England joining other European central banks in the descent from what seems like peak rates for the cycle following months of speculation over the direction of interest rates. Furthermore, over the last month we’ve had a new government take seats in the UK and France following elections being pulled forward in both countries, a “switch-a-roo” in the Democrat candidate in upcoming elections following near assassination attempt on Trump and a rise of tensions in the middle east. Taking a step back and looking at the bigger picture, at a time when geopolitical uncertainty is widespread the UK can boast some stability with a clean sweep from the Labour party and subsequent policy indications.  

From a wider macro perspective, we are also seeing early signs of stability and a positive set-up for the broader infrastructure sector. Inflation coming under control with economies cooling and major central banks embarking on rate-cutting cycles will lead to lower pressures on company-level cost of capital, investor-driven portfolio rebalancing efforts and an improvement in the market’s perception towards defensive yielding assets. Combining the macro, the bottom-up fundamental prospects of the sector and historically low valuations, the setup for forward looking returns for FIIF is solid and we remain optimistic on the outlook. 

The continued bifurcation in market cap between the winners and losers in the sector is validating our preference to own the higher quality companies, while the strong interest from private markets for infrastructure assets is evident through the marks on disposals from portfolio companies and mounting dry powder in private funds. FCM continue to anticipate a favourable fundamental and policy environment for the sector and expect the list of catalysts to positively drive forward looking performance for the Fund. With the Fund positioned increasingly towards growth opportunities, a starting dividend yield over 6% with dividends expected to grow over the next 12 months and c. 17% discount to underlying NAVs, FIIF remains well positioned to deliver as per expectations and FCM remain vigilant in taking advantage of future opportunities