Are there enough infrastructure opportunities in the UK?
The bigger projects are well bid for and prices are on the high side so there is a lot of capital chasing limited opportunities. However, there seems to be a sweet spot in the UK of projects in the £5m to £20m range, which fall outside the radar of a lot of infrastructure funds because they are too small and banks are not willing to lend to them because the ticket size is too small. So for a fund of our size, tickets in the £5m to £15m range makes sense. We have done a number of projects of that size and are pleased with the returns. If you do half a dozen of them you have £60m (1% of the fund), which is a sensible investment to do.
What type of projects are these?
They are renewable energy-type projects including anaerobic digestion plants and biomass, but not so much solar. On these smaller projects we are seeing low doubledigit returns, which we feel is very satisfactory, but for some of the more established infrastructure funds the returns are definitely lower. Over three years our infrastructure has returned 7% and 12.8% over one year.
What other opportunities are you looking at?
There are some interesting opportunities around royalties and what I call regulatory arbitrage. With regard to the latter, mainly in financial institutions where the regulations change and it makes certain assets expensive for banks to hold and there is an opportunity to either buy them or get exposure to them. On the royalties side we have done a couple of healthcare royalty funds, where small pharmaceutical companies develop a drug and patent it and then often need distribution from a large pharmaceutical company which will pay them a royalty for every unit sold. That stream of income is pretty transparent because there is little risk of competitor drugs coming in as the FDA drug approval process is quite slow. Often those companies then look to develop the next drug, so instead of just distributing that money to shareholders they invest in new facilities and drugs and effectively, we can lend against that royalty income. Our lending is safe because it is really against the big pharma company, not against the small drug company hoping to discover the next blockbuster.
You have also changed your property portfolio.
We own 27 properties throughout the UK, most of which is direct, and we have slowly been improving the quality of the portfolio and repurposing it. We realised we had too much in office space and over the last four years we have tried to have a bit more in industrial. We also had a number of smallholdings we have tidied up and more recently sold some of our weaker properties. Property is starting to get a bit warm and some of the secondary properties have seen a bit of strength recently, so we took the opportunity to sell some of those. Our expectation is returns won’t come from capital growth but from income, so we are looking to recycle the money into primer properties where we think there is better scope for income growth; if interest rates start to rise, secondary properties won’t see capital appreciation as yield compression has probably gone almost as far as it will, so you are more likely to get rental growth from primer sites. We are also underrepresented in London because of prices, so we have been selling properties in London and the challenge is unit size. We would like a London office, but they are very expensive, not only in terms of the yield you are buying on, but in terms of the amount you need to divvy up – an office block in London is going to cost anything from £100m to £1bn and that does not give us sufficient diversification.
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