Why these defensive investments will continue to deliver

Amid a sea of red this year, one sector is flashing green. Here's why it has provided a refuge and delivered positive return.

Investors have had very few places to hide this year, as rising interest rates and inflation spark an exodus from the stock market.

Year-to-date, US shares have fallen around 20% (S&P 500 in dollar terms). Shares on a global scale (MSCI World Index) have tumbled a similar amount, and UK stocks (FTSE All Share Index) have dropped 7.5%.

But one sector has provided a refuge and delivered positive return: infrastructure and renewable energy investment trusts.

Covering both physical renewable energy assets, such as wind turbines and solar farms, as well as schools, roads and hospitals in the traditional infrastructure sector, the typical fund in these spaces have made money over the past year, three years, five years – and more than doubled returns over 10 years.

Particularly impressive are renewable energy infrastructure investment trusts, which have returned on average 13% over the past 12 months, compared with a 0.5% loss for the FTSE All Share. Traditional infrastructure investment trusts have returned 3% over the past year on average.

Top performers over the past 12 months include 43% for Gresham House Energy Storage, 32% for JLEN Environmental Assets, and a 13% return for 3i Infrastructure Ord (LSE:3IN).

Infrastructure assets are prized for their consistent and inflation-linked income, which will keep being paid even during a recession. They also own physical assets, which tend to increase in value when there is inflation.

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Even after a strong run over the past year, Matthew Read, senior analyst at investment trust analyst QuotedData, argues they continue to be excellent defensive investments.

He said: “While rising interest rates have been depressing the valuations of growth stocks, infrastructure investments have been finding favour as they offer certainty in current volatile markets and provide a completely different return profile to the types of investments that the market is shunning today.”

He adds that infrastructure assets, including renewable energy, have long lives, with a 25-year asset life very achievable and some lasting 100 years.

Another selling point, he argues, is that infrastructure can be essential to society. “In return for financing them, investors can expect to receive regular reliable income derived from revenues that tend to be based on their availability to be used, with a strong degree of inflation linkage,” he said.

Natural inflation protection

Inflation can even be beneficial for infrastructure trusts, notes Read. He said the net asset value (NAV) of renewables funds had been rising as inflation has accelerated this year.

For example, he notes that JLEN Environmental Assets registered a 15% NAV increase in the first three months of 2022, mostly due to inflation linkage.

“Overall, the returns from infrastructure assets are resilient and should hold up well during a recession. Not surprisingly, premiums on these funds have been expanding as uncertainty and inflation expectations have grown,” he said.

Evert Castelein, fund Manager at abrdn European Logistics Income, adds that this advantage is even more prevalent in mainland Europe:

“A typical lease agreement on the continent benefits from annual indexation of rents, providing a hedge against inflation.

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“This is one of the reasons why the focus of this income-driven strategy has been aimed at the mainland Europe. Of the company’s current expected rental income, 69% has uncapped consumer price index (CPI) indexation built in, 23% has a maximum cap and 7% is subject to a German threshold indexation clause in the lease agreement.

“As an example, just recently the company has agreed with the tenant CPI indexation on a lease for one of our large Spanish assets. With inflation levels where they are, this has resulted in a 7.2% per annum rental uplift,” he said.

Edward Hunt, manager of HICL Infrastructure, also says that high inflation and greater market volatility support the relative attractiveness of core infrastructure for investors.

“HICL’s portfolio has been deliberately positioned to offer strong inflation protection, low correlation to stock markets, and attractive, predictable income,” he said.

Another infrastructure manager, Giles Frost, of International Public Partnerships, says its public infrastructure investments benefit from revenues that are paid for or regulated by government, with most revenues explicitly linked to inflation without caps.

He said: “So, while inflation linkage in the portfolio may vary from investment to investment, we calculate that on average INPP’s overall return from its portfolio is expected to increase by 0.7% a year in response to every 1% a year increase in inflation.”

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One risk to the renewable energy infrastructure sector, amid rising energy costs and a crunch on household income, is windfall taxes on profits.

Talk of windfall taxes briefly depressed valuations at some of the renewable funds, even pausing Bluefield Solar’s fundraise. But Read say that any share price drops were temporary as investors still bought into the investment story and around renewable energy assets. Bluefield Solar ended up successfully raising the £150 million it was seeking from investors.

He said: “With a global focus on decarbonisation, renewable infrastructure has long-term structural growth areas.

“The same can be said of infrastructure funds, given the need to replace ageing infrastructure in the developed world to boost growth, against a backdrop of indebted governments trying to shrink expenditure. This theme has a long way to run.”

Frédérique Carrier, head of investment strategy at RBC Wealth Management, adds that even the conflict in Ukraine, which is increasing the importance of fossil fuels, could accelerate the green energy transition.

She said: “Russia’s predatory move on Ukraine is pitting energy security against energy transition for many countries. Governments are shifting energy policies back in favour of fossil fuels in the short term, raising fears the energy transition may end up on the back burner.

“But the new focus on energy security doesn’t irrevocably threaten the climate change mitigation agenda. Rather, the green energy transition, while slowing in the near term in some areas, is very likely to accelerate in others, particularly in Europe.”

Where to invest:

Read suggests investors look at 3i infrastructure, which invests in utilities and transport, GCP Infrastructure, which funds infrastructure projects, and HICL Infrastructure, which owns a diverse range of infrastructure assets.

For renewable energy infrastructure, he highlights Bluefield Solar, NextEnergy Solar, Downing Renewables, Greencoat UK Wind and JLEN Environmental Assets as strong investment options

FTF ClearBridge Global Infrastructure Income and FP Foresight Global Real Infrastructure are members of interactive investor’s Super 60 and ACE 40 lists.