Roundtable: What investment solutions for long-term infrastructure investors?
EDHECinfra organised its first industry event on 16 March 2016 in the heart of the City of London. More than a hundred participants attended the event, which included a roundtable covering a wide range of perspectives on infrastructure investment: from a defined-benefit Canadian pension plan, to a German re-insurer, the European regulator of insurance and pensions, the G20’s Global Infrastructure Hub and the OECD.
Brer Adams from the Global Infratructure Hub highlighted the need to create a pipeline of investable assets, especially in emerging markets where well identified opportunities are less forthcoming. He described the GI Hub’s project to better document future infrastructure investments in non-OECD markets and highlighted the joint work done with EDHEC on better understanding investor preferences through an in-depth industry survey (see below).
The panel discussed the reasons why a number of investors prefer to invest directly in large, sometimes very large infrastructure assets. The immediate objective to reduce fees has to be balanced with less visible costs of forgoing diversification benefits and shouldering internal costs.
It was also recognised that adequate investment products in infrastructure were few and far between for institutional investors of any size.
Investor perspectives: the search for factors has begun
Rossitsa Stoyanova of CPPIB highlighted that the greatest challenge when it came to infrastructure investing is the total absence of data. While there is data available for other illiquid assets such as private equity or real, infrastructure investment suffers from a dearth of available data. She explained that the use of public market proxy is also very unsatisfactory and that better measures were sorely needed to better understand the role that infrastructure could play in a portoflio.
CPPIB’s reasons for investing in unlisted infrastructure equity were to achieve diversification benefits, while being exposed to a low beta and significant duration. However, Ms Stoyanova also said that she expected infrastructure investments to yield an illiquidity premium. In fact, CPPIB now wants to look at infrastructure investment through a risk factor lens, thus ensuring compatibility with the rest of its portfolio approach.
Peter Schenck of MEAG highlighted that the perspective of an insurer differs insofar as it is looking at infrastructure investment directly from an LDI perpsoective and also in the context of a broader fixed income portfolio. He argued that he expects to see a combination of risk exposures and risk premia in infrastructure investments that is relevant to their portfolio objectives but also insisted that without data it was very hard to calibrate risk sensitivities.
Dr Schenck also remarked that infrastructure investment “is complicated” and that several types of due diligence processes are necessary, including in the tax and accounting sides and that it would be difficult to do if they were not a large organisation with plenty of internal skills available. Another difficulty highlighted by Dr Schenck is the difficulty to estimate long-term sustainability, including the – almost certain – changes in regulation and public policy over an investment period of several decades.
Both pension plans and insurers expressed the view that they aimed to build a more diversified portfolio over time and that direct investment in infrastructure was justified in large part by their size and investment horizon.
Preview of the EDHEC/GI Hub survey
Frederic Blanc-Brude, Director of EDHECinfra, presented early results of an EDHEC/GIH Survey of more than 180 institutional investors and infrastructure managers, which were unveiled at the event, included the fact that three quarters of investors consider the classic “infrastructure PE fund” not to add value and even to be “obsolete”.
Likewise, more than half of respondents to the survey have said that they did no trust the valuations reported by infrastructure managers. In other words, they do not know what their returns really are.
Overall, 96% of respondents concurred that there is no useable benchmark of private infrastructure investment available today.
Policy and regulation evolutions
Dr Tomas Walter of EIOPA provided an overview of the recent discussions aiming at defining qualifying “infrastructure assets” in the context of prudential regulation.
He highlighted three criteria :
(1) to have predictable cashflows, there needs to be contracted revenues that are subjected to regulation and a limited demand resulting from provision of essential services;
(2) there can be a security package, referring to project finance; and
(3) stress resilience – stress tests needs to be conducted on cashflows to ensure that projects can meet their obligations under stress conditions.
Beyond thee, there can be additional criteria for unrated debt and equity e.g. reasonable leverage, proper mitigated construction risks, limited operational risks etc..
Dr Walter explained that with infrastructure investment so far, due to teh lack of data, the approach has been principle-based and that this has meant extensive additional discussions between insurers and supervisors.
Finally, Raffaele Delacroce of the OECD reminded the audience that today the majority of pension funds are not considering infrastructure investment because of the lack of data, benchmarking and understanding of what the infrastructure proposition is.
He detailed the OECD’s approach to improve matching demand and supply of long-term capital along three main priorities:
(1) reducing uncertainty for the private sector by addressing regulatory risk, political risks, efficiency of the government to deliver projects on time, standardising legal documentation and addressing the information gap – transparency.
(2) tackling constraints hindering the development of financial markets;
(3) leveraging private sector money through risk sharing mechanisms between the public and private sector through procurement structures which can vary (e.g. PPPs)
There is a still big debate going on in OECD /G20 countries about which is the best delivery model that would attract investors while optimising public-private risk sharing.
New empirical results
The event was also the opportunity to present some of EDHECinfra‘s latest empirical findings in the private infrastructure equity and debt spaces, which were also published on the same occasion.
They include a new paper on the dynamics of debt service cover ratios in infrastructure projects and implications for credit risk modelling and measurement (paper available here) and a ground-breaking study of the difference of behaviour of infrastructure firms cash flows and payouts when compared to non-infrastructure firms (paper available here).