How InvITs can add yield to your investment portfolio

Both InvITs and Reits have been in the spotlight recently, with mutual fund houses advocating for a dedicated category for these investment vehicles. While capital markets regulator Sebi is yet to take a decision on this, it has been contemplating the introduction of norms for follow-on public offers (FPOs) by InvITs and Reits.

InvITs are short for infrastructure investment trusts and Reits stand for real estate investment trusts.

While hybrid and multi-asset funds have some exposure to these asset classes, they are increasingly viewed as stand-alone categories deserving specialized schemes. The significance of Reits and InvITs has grown substantially over the years, with mutual funds currently having an exposure of ₹8,416 crore to these instruments as of 30 September.

InvITs were launched in 2017 but remain somewhat unfamiliar to many investors. These innovative financial instruments are designed to raise capital by issuing units to investors, which are then channelled into infrastructure assets. InvITs are a crucial means of funding, enabling individuals to collectively invest in and benefit from various infrastructure projects.

InvITs are diverse in their asset portfolios, owning and managing completed or under-construction projects that encompass an array of critical infrastructure sectors. These assets may include highways, power transmission networks, telecom towers, fibre optic networks, and more. Notably, there are 22 Sebi-registered InvITs in India, but only three are publicly listed and liquid: IndiGrid InvIT, PowerGrid InvIT, and IRB InvIT. The former two focus on power transmission assets, while the latter invests in a portfolio of road assets, collecting tolls over the residual life of the asset.

How InvITs are structured

InvITs are akin to mutual funds in their structure and function. They aggregate investments from numerous individual and institutional investors, which are then strategically deployed into infrastructure projects. Expert fund managers oversee InvITs, just as they do for mutual funds, ensuring efficient management and a potentially steady income stream for unit holders. These trusts serve as a gateway for investors to participate in India’s infrastructure growth story while allowing them to enjoy the benefits of regular income and portfolio diversification.

To establish an InvIT, there can be up to three sponsors, each with a minimum net worth of ₹100 crore and at least five years of experience in infrastructure development or fund management. Sponsors must hold a minimum 15% stake in the InvIT. The investment manager overseeing asset activities, should have a net worth of ₹10 crore and 5 years of advisory or infrastructure development experience. If owned by a non-Indian, the investments are considered foreign. The trustee holds assets for unit holders, while the project manager ensures timely project completion.

Hybrid investment avenue

Investors should seriously consider adding InvITs to their portfolio for several compelling reasons, say experts. InvITs promise a steady stream of cash flows thanks to Sebi’s regulation that mandates at least 80% of assets to be allocated to completed, income-generating projects and restricts investments in under-construction projects to 10%. Moreover, Sebi stipulates a minimum distribution of 90% of net distributable cash flows, leading to a robust distribution per unit (DPU) and substantial dividends for investors.

What makes InvITs even more appealing is their unique blend of characteristics. They offer the predictability of debt-like payments while also providing opportunities for investors to participate in the company’s growth journey, potentially resulting in capital gains, higher DPU, and the acquisition of new assets. This harmonious mix of stability and growth positions InvITs as an attractive investment avenue.

Key metrics over the past year

IndiGrid has over the past year increased its number of assets from 14 to 17. The residual life of its assets has decreased from 30 years to 27 years. Net debt as a percentage of assets under management (AUM) also saw a slight increase, rising from 56% to 60.10%. However, the net asset value (NAV) showed a minimal decline from 132 to 130.5.

In contrast, PowerGrid maintained a consistent number of assets at 5, with a negligible change in residual life from 35 years to a little more than 29 years. The ratio of net debt to AUM decreased significantly from 4.80% to 0.91%, showcasing improved financial health. Although the NAV for PowerGrid wasn’t available, there has been a reduction in debt ratio and this is indicative of a positive financial trend.

IRB Infra InvIT witnessed a growth in assets, expanding from 5 to 6+2 (implying 6 operational and 2 under-construction assets) and a decrease in the residual life of these assets from 4-20 years to 3-19 years. The net debt-AUM ratio remained relatively stable at 31.97% and later decreased to 30%. Their NAV increased from 101 to 103.

Near term challenges

As yields go up, the interest payments on flexible-rate debt within the InvIT can surge, leading to higher expenses and a potential reduction in DPU. Furthermore, rising debt costs can result in increased refinancing expenses when maturing debt needs replacement. Effective interest rate risk management, such as diversification and hedging strategies, is vital for InvITs to navigate these challenges and sustain attractive yields for investors.

Vishal Chandiramani, managing partner and chief operating officer of TrustPlutus Wealth Managers, attributes the recent performance decline of Infrastructure Investment Trusts (InvITs) partly to their inherent quasi debt nature. As yields rise, other fixed income instruments become attractive thereby diminishing the appeal of InvITs. Specific to InvITs like PowerGrid, delays in asset acquisition as compared to market expectations may have also led to the recent correction.

Chandiramani maintains a long-term positive outlook on InvITs, believing that over the next 3-5 years, they will regain momentum, offering a promising accumulation opportunity.

The yields from InvITs

Checking the current distribution yield gives a fair picture of the returns that investors can expect from InvITs. It is calculated by dividing the distributed income per annum by the current market price. An investor can continue to earn the yield at the time of investment if the cash flows for the company and distributions are sustained in the future years.

PowerGrid’s distribution yield experienced a significant increase, rising from 9.30% to 12.07%, while both IndiGrid and IRB Infra InvIT displayed more modest changes from 9.29% to 10.02% and 12.30% to 11.40%, respectively.

Tax complications

The finance minister introduced a significant change in the tax treatment of income from InvITs and Reits in the Union Budget this year. The move aimed to address the taxation of ‘loan repayment’ income received by unit holders. Initially, this income was proposed to be taxed under ‘income from other sources’ at slab rates. However, industry experts raised concerns over the treatment of capital gains as ‘other income’ subject to tax at individual slab rates.

To address this, the government modified the Budget proposal. Under the amended rules, the ‘loan repayment’ income must be deducted from the cost of acquisition at the time of unit sale. For instance, if a unit was purchased at ₹500, sold after 3 years at ₹600, and received ₹70 as ‘loan repayment’ during the holding period, the capital gains would be calculated based on a reduced cost of ₹430, resulting in capital gains of ₹170, not ₹100.

It is important to note that this capital gains tax treatment for the ‘loan repayment’ component is not a permanent change. It will be in effect until the total ‘loan repayment’ income received by the unit holder is equal to the initial cost of acquisition. After this threshold is reached, the ‘loan repayment’ will be treated as ‘income from other sources’ once again, attracting tax at slab rates.

Investors, say experts, need not be concerned about the recent tax changes regarding ‘loan repayment’ income from InvITs and Reits, as it would take around 15 to 20 years for these changes to have a substantial impact.