On a concession that ends at zero, part of every distribution is your own capital coming back.
Cash yield is the year's distributions divided by the equity invested (yield on cost) or by the opening NAV (yield on NAV). It is not a return: on an asset with a terminal value it sits below the IRR, and on a concession that ends at zero it includes the repayment of your own capital. An illustrative 15-year concession bought at a 9.0 per cent cash yield returns an IRR of only 6.25 per cent, less than a 5.5 per cent yielding utility-type asset that returns 8.00.
Worked in full in The Infrastructure Investment Analyst by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Core infrastructure is sold on cash yield, and the comparison that misleads is between a long-lived asset with a terminal value and a concession that hands back to the grantor. Both cost 100 of equity, both grow distributions with inflation. Every figure is illustrative.
| Input | Asset A: perpetual-type | Asset B: concession |
|---|---|---|
| Equity invested | 100.0 | 100.0 |
| Year 1 distribution | 5.50 | 9.00 |
| Starting cash yield on cost | 5.5% | 9.0% |
| Distribution growth, per year | 2.5% | 2.5% |
| Horizon | 10-year hold | 15 years to hand-back |
| Value at the end | Sold at a 5.5% yield | Nil |
Cash yield on cost, year t = distributionst / equity invested
Cash yield on NAV, year t = distributionst / NAV at the start of year t
IRR: the rate r at which -100 + sum of distributionst / (1 + r)t + exit value / (1 + r)n = 0
Asset A: distributions rise from 5.50 to 6.87 in year 10 and total 61.62; the exit at a 5.5 per cent yield on year-11 distributions is 128.01. IRR = 8.00%, which is the Gordon identity: yield 5.5 plus growth 2.5.
Asset B: distributions rise from 9.00 to 12.72 in year 15 and total 161.39; there is no exit value. IRR = 6.25%.
In Excel, with cash flows in B2:Q2 including the -100 at time zero: =IRR(B2:Q2); cash yield on cost is =C2/-$B$2 copied across.
| Measure | Asset A | Asset B |
|---|---|---|
| Year 1 cash yield | 5.5% | 9.0% |
| Average cash yield on cost over the horizon | 6.16% | 10.76% |
| Total cash returned / equity (MOIC) | 1.90x | 1.61x |
| IRR | 8.00% | 6.25% |
Asset B pays out far more cash in year 1, 9.00 against 5.50, and returns less. The reason is that its distributions are doing two jobs. Part is the return on capital, and part is the return of capital, because by year 15 the investment is worth nothing. On Asset A, by contrast, the capital is returned in the exit price, which is 67.5 per cent of all the cash the investor receives; distributions are pure income, so the cash yield understates the return by the growth rate.
Value Asset B each year at its own IRR and the yield on NAV climbs as the NAV runs down. The distribution in excess of the IRR on opening NAV is capital going back to the investor.
| Year | Opening NAV | Distribution | Yield on NAV | Of which return of capital |
|---|---|---|---|---|
| 1 | 100.00 | 9.00 | 9.0% | 2.75 |
| 5 | 86.49 | 9.93 | 11.5% | 4.53 |
| 10 | 58.13 | 11.24 | 19.3% | 7.61 |
| 15 | 11.97 | 12.72 | 106.2% | 11.97 |
A 19.3 per cent yield on NAV in year 10 is not an outstanding year. It is a concession with five years left, distributing the last of its capital.
Holding the 9.0 per cent starting yield and 2.5 per cent growth, the IRR depends almost entirely on how many years of distributions remain.
| Years remaining | IRR | Cash yield minus IRR, points |
|---|---|---|
| 15 | 6.25% | 2.75 |
| 20 | 8.74% | 0.26 |
| 25 | 9.94% | -0.94 |
| 30 | 10.57% | -1.57 |
Around 20 years the yield and the IRR roughly coincide; beyond that, growth outweighs the run-off and the IRR exceeds the yield. To match Asset A's 8.00 per cent IRR, the 15-year concession would have to be bought at a starting cash yield of 10.12 per cent.
The same issue appears at fund level. An open-ended infrastructure fund holding a mix of perpetual-type assets and concessions reports one distribution yield, and that yield rises as the concessions age even if nothing improves. Investors comparing funds on distribution yield should ask for the weighted remaining life of the portfolio and for the share of distributions that is return of capital, because two funds with the same yield can be earning very different returns. The fund-level version of the question, how much of a distribution is covered by income rather than paid from capital, is worked in whether an evergreen fund's distribution yield is its return.
The error is to rank assets, or funds, on cash yield, as if it were the income component of a return that also has a capital component. That holds only when the capital is preserved. For a finite-life asset, part of the yield is a liquidating distribution, and a portfolio built on high yields from short concessions will report attractive cash yields while its NAV runs off. Always compute the IRR alongside the yield, and when reporting yield on NAV, show how much of the distribution is return of capital.
Cash yield is distributions over cost or NAV; the return is the IRR, and on a concession the two are separated by the remaining life. Here a 9.0 per cent yield on 15 years returns 6.25 per cent, while 5.5 per cent on a perpetual asset returns 8.00. The book's own concession cases, with exits valued on the years that actually remain, are in the free workbooks for this book; for the exit side, see valuing a concession with no terminal value.
Cash yield is one year's distributions over cost or NAV; IRR is the annualised return on all cash flows including the exit. For an asset with a terminal value, IRR is roughly yield plus growth: 5.5 plus 2.5 gives 8.00 per cent. For a concession that ends at zero, the yield includes return of capital and can exceed the IRR.
With distributions growing at 2.5 per cent a year and nothing left at hand-back, the illustrative concession needs a starting cash yield of 10.12 per cent to earn an 8.00 per cent IRR. At a 9.0 per cent starting yield it earns 6.25 per cent.
The NAV falls as the remaining years run off while distributions keep growing. On the illustrative 15-year concession, yield on NAV is 9.0 per cent in year 1, 19.3 per cent in year 10 and over 100 per cent in the final year, because the last distribution returns the remaining 11.97 of capital.
This article is one calculation from The Infrastructure Investment Analyst. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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