This trust offers a high yield at an even higher discount

Income stocks are faring well too, with companies such as Vodafone (VOD) and M&G (MNG) offering yields north of 9 per cent. Some investment trusts are even more enticing, with Henderson Far East Income (HFEL) offering 10.1 per cent.

Investors who are seeking a juicy income with less equity risk – but who want something more adventurous than a government bond – might want to consider infrastructure, however. The infrastructure sector currently boasts an average yield of nearly 6 per cent, according to the Association of Investment Companies, with renewable energy infrastructure on 7.9 per cent.

Many of these trusts are also still trading on big share price discounts to their net asset values (NAVs), ostensibly granting a margin of safety for bargain hunters.

It’s important to realise, however, that these discounts reflect very real issues, especially when it comes to income generation. Two of the UK’s three battery storage trusts have had to scrap dividends in the face of revenue struggles, while balance sheet issues caused Digital 9 Infrastructure (DG19) to stop its dividend and begin the process of winding up. Names such as the US Solar Fund (USF) and Asian Energy Impact (AEIT) have had their own idiosyncratic issues, and the broader sector looks vulnerable to further disruption, with wide discounts making drastic action such as merger activity more likely.

What, then, is the solution for investors who do want exposure? One sensible approach is to back the bigger, more established trusts. These tend to be liquid, come with experienced management teams and, importantly, offer a diversified portfolio of assets. Many of these assets, which include hospitals, toll roads and wind farms, provide a reliable income that is regulated or government-backed, and have a good degree of inflation linkage.

HICL Infrastructure (HICL) is one of the most prominent names in the sector and manages to tick many of our boxes. The shares sit on a 6.6 per cent yield and a 22 per cent discount to NAV, making it more attractive on both metrics than rivals International Public Partnerships (INPP) and BBGI Global Infrastructure (BBGI).

HICL was the first infrastructure fund to join the London Stock Exchange in 2006 and has a good level of diversification: the portfolio is spread across multiple sectors, with transport accounting for 30 per cent of assets at the end of September, health accounting for 21 per cent, electricity and water for 17 per cent and education for 10 per cent.

Some 63 per cent of the portfolio is based in the UK, but 20 per cent is in Europe, 11 per cent in North America and 6 per cent in Australia and New Zealand. A look at revenue types in the portfolio also reveals a decent mix, with 63 per cent of revenues classed as ‘contracted’, 20 per cent ‘regulated’ and 17 per cent ‘demand-based’.

HICL, with its long track record and lowly valuation, certainly looks like an obvious option for income investors wanting to branch out. It has also made good progress in addressing problems of its own, although investors would do well to understand how the portfolio is changing.

Dividend dilemma 

It has tended to be newer funds in less mature subsectors that have caused the biggest dividend woes. However, HICL has had a few worries of its own.

As Peel Hunt analysts lamented last November, shareholders have had to endure several years of no dividend growth. The payout has been held at 8.25p per share since 2020 and is not due to budge until FY2026, when it is set to rise to 8.35p. This income plateau compares poorly with other core infrastructure funds that have managed to up their dividends, and represents a very real trade-off for the trust’s cheaper price tag. The plateau partly relates to a shift in the sort of assets HICL holds – more of which later.

Some progress has been made on the dividend front, however. Affinity Water, the biggest position in the portfolio at 7.7 per cent, has been unable to distribute income since 2019 as part of an agreement with regulator Ofwat amid concerns about the financial resilience of water companies.

However, Affinity Water looks as though it may be coming out of the crisis stronger. As Kepler analysts observed in a note published in December, dividends not paid out by Affinity are effectively reinvested in the business, potentially creating scope for higher future payouts. It’s not the case that the money isn’t there. 

HICL’s investment manager InfraRed is hopeful that revenues from Affinity Water should return in the 2026 financial year.

A fund in transition

Investors who want more immediate signs of improvement can point to the fact that the management team has been busy overhauling the portfolio. In the year to 31 March, £509mn of assets were disposed of, including four public private partnership (PPP) projects, part of a US toll road and University of Sheffield accommodation. The team, meanwhile, put £227mn of cash to work in three assets: Altitude Infra, a fibre network in rural France, Hornsea II OFTO, an electricity transmission project in the UK, and a French motorway.

Why does this matter? For starters, HICL is using some of its sale proceeds to reduce its exposure to floating rate debt, which can prove expensive in a time of higher interest rates. This should leave its finances in better shape and could free up more cash for useful future activities, be it funding the dividend or following other trusts in carrying out significant share buybacks. (It has just announced a £50mn buyback fuelled by the “significant level of transactions” in 2023.)

Such activity is also part of a gradual attempt to diversify the fund away from PPP assets – typically contracts with the government to run social infrastructure services such as hospitals and schools – and more into regulated and demand-based assets. This is reflected in the fact the team has made big new investments in areas such as electricity transmission and transport in its recent history.

The rationale, as Kepler puts it, has been “to extend the average life of the income derived from the portfolio, improve the inflation linkage and broaden the exposure of the portfolio to minimise investment risk”. The fact that many PPP projects will expire in the coming years is also highly relevant. 

Whether such diversification will pay off is up for debate. Peel Hunt has argued that the shift has had “little benefit” for shareholders, evidenced by Affinity Water’s regulatory troubles, the flat dividend and the fact that demand-based revenues faltered during the pandemic. Kepler’s team concedes that recent HICL investments might be characterised as being “more growthy” than PPP assets, which could invite greater risk.

There are reasons to be optimistic about its short and long-term prospects, however. The situation at Affinity Water seems to be improving and revenue from demand-based assets is recovering in the wake of the pandemic. The portfolio shifts also mean HICL now has greater inflation linkage, something that could boost returns for some time to come (overall, inflation is expected to contribute £1.3bn of extra cash flows between now and 2050, with forecasts up by 17 per cent since September 2021). 

HICL is not a perfect fund, but it has a rich dividend yield, a low valuation, and plenty of potential to improve. With smaller rivals struggling, this sector stalwart should continue to hold its own.