Infrastructure prices don’t show bubble

This blog was initially published in top1000funds.com. Infrastructure equity prices do not exist in a vacuum. Analysing hundreds of transactions over the last 15 years, we found that they are driven by systematic risk factors, which can be found across asset classes. In other words, markets did process information rationally and average prices did reflect buyers’ and sellers’ views and preferences for taking risk. These risk factors (size, leverage, profit, term spread or value) are commonplace for sharemarket investors. After all, unlisted infrastructure equity is still equity. As a result, unlisted infrastructure prices have been partly correlated with public markets over the last 15 years. The price formation process happened almost in slow-motion, however, because of the illiquid nature of the unlisted infrastructure market. The raw data shows unlisted infrastructure companies such as ports, airports and merchant power, experienced a sharp drop in revenue in 2009. But unlike stocks, the effect on valuations was not immediate because few transactions took place at the time. This shock to revenues and earnings impacted transaction prices only later on. Then, in 2011, despite revenue growth being either stable or still declining, average infrastructure valuations began rising rapidly. This continued until 2016. Not all sectors peaked at the same time. For instance, the power sector started a new price decline in 2015. In contrast, airports had their highest average valuations increase in that period. By 2017, despite the return of revenue growth, average prices …

Infrastructure: Calling time on borrowed definitions

This blog was originally published in IP&E Real Assets. Infrastructure as an asset class has evolved over the past 10 years. In that evolution, it has taken classifications and definitions from private equity and real estate, such as core and core-plus. Recently asset managers have launched investment products offering value-add strategies and increasingly the line between private equity and infrastructure has blurred. The trouble with inherited labels is that they provide no clear definition of infrastructure that suits all dimensions and risk profiles of the asset class, often giving managers licence to make spurious investments. As infrastructure investment grows, the boundaries are being stretched by some asset managers investing in real estate-type assets with infrastructure value-add labels slapped on top. Investors are often confused as to what core, core-plus, value-add and super-core products encompass. Generally they are a way for managers to justify return targets. The infrastructure sector does itself a disservice without a clear structure and definition of the strategies it can offer investors. Without a proper taxonomy providing a set of criteria to define infrastructure, it is hard for asset managers to structure the solutions that investors need. So what is infrastructure? There are several definitions. The OECD and World Bank use definitions based on public policy. Meanwhile, regulators focus on what infrastructure ‘is like’ in order to qualify it under various prudential frameworks. Under Basel II and Solvency II, regulators apply definitions that try to differentiate how …

Does Europe need a new model for private roads?

Private investment in European roads is under fire once more. The typical charge against the ubiquitous motorway concessions crossing France, Italy or Spain is that, as quasi-monopolies, they have a nasty tendency to under-invest and over-charge. This assertion is taking on new meaning as road infrastructure ages, and lack of sufficient maintenance and investment could lead to new catastrophes like the Morandi bridge collapse. Populists, not only in Italy but also in the rest of Europe, have even concluded that the deaths are a direct consequence of the concessionaire’s search for the highest profits. Even though one should not overreact after the Genoa tragedy, one may ask whether the European model of private road concessions is fit for purpose. And all the more so in that the Juncker plan and other grand designs for European transport corridors envisage much more private investment in infrastructure. Is Autostrade per l’Italia a bad egg or do we need a different model to invest Europe’s long-term savings in its road network without facing the charge of low quality and excess profits? It is easy to imagine Autostrade allowing the Morandi bridge to suffer under increasing heavy vehicle traffic without taking sufficient action to maintain it, until it was too late. This bridge certainly needed to be closed and re-built, but under-investment in this kind of infrastructure asset is a more pervasive problem, driven by the regulatory framework of the European road sector. Looking at …

Three routes to maximizing infrastructure finance for development

Frédéric Blanc-Brude (Director, EDHECinfra) By promoting better standards, methods and benchmarking, development finance institutions can move the mountain that is preventing institutional capital from flowing into infrastructure. The World Bank’s initiative to maximize finance for development (MFD) aims to “find solutions to crowd in all possible sources of finance, innovation, and expertise” in order to achieve the Sustainable Development Goals (SGDs). In the case of infrastructure investment, a significant contribution to long-term sources of private finance is expected from institutional investors such as  pension plans, life insurers or sovereign wealth funds. These investors have become increasingly interested in infrastructure investment in recent years, in search for new sources of returns, diversification, duration and inflation hedging. However, they cannot be expected to make a substantial and durable contribution to the long-term financing of infrastructure if three important changes do not take place: Valuation methodologies need to improve to represent financial performance more accurately. Current valuation methodologies used in private infrastructure are wrong. 50% of the respondents of the largest survey of asset owners ever undertaken (by EDHEC on behalf of the G20) agree with this statement (1). Discounting 25 years of ‘base case’ cash flows using a single discount rate build from ad hoc risk premia assumptions, with little regard for the term structure of risk that characterizes infrastructure firms contradicts basic corporate finance textbooks. It is easy to do a lot better. Advanced private asset pricing techniques using stochastic DCF …

An industry standard for the infrastructure asset class

Sarah Tame (Associate Director and Chief Communication Officer, EDHECinfra) Today infrastructure investors use ad hoc benchmarks for unlisted infrastructure investment. We wish to establish an industry standard for the infrastructure asset class. EDHECinfra has made significant process, establishing a framework for data collection and developing asset pricing techniques to measure the risk adjusted performance of private infrastructure. From this foundation we can now build market indices for infrastructure. But what are the most relevant broad market indices for investors? Do they wish to invest in infrastructure along the same geographic or sector categories as that of the bond or equity markets? Are infrastructure investors focusing on a different segmentation of the universe? In other words, what would be the industry standard for unlisted infrastructure market indices and sub-indices? We recently conducted one of the largest surveys of infrastructure investors globally, with more than 200 respondents, in order to establish their preferences for the segmentation of infrastructure. The majority of respondents to the survey were asset owners, and over half were focused solely on infrastructure equity investment, while a third seek both infrastructure equity and debt. When questioned about geographic segmentation of infrastructure the geographies of standard capital market benchmarks were the least preferred, with less than 10% of responses. Instead respondents said economic development and infrastructure investability was considered the most relevant. For debt markets the level of economic development is also the most frequently proposed segmentation across all respondents. …

Building benchmarks for infrastructure investors: a long but worthwhile journey

This blog was originally published on the World Bank’s PPP Blog Website. The Argentinian presidency of the G20 opens this month and will be marked by a focus on infrastructure investment. The G20 and OECD have already announced a wide-scale data collection initiative for the purpose of creating benchmarks of the risk-adjusted financial performance of private infrastructure debt and equity investments. It is about time. Investors hit a roadblock when investing in infrastructure. Until now none of the metrics needed by investors were documented in a robust manner, if at all, for privately held infrastructure equity or debt. This has left investors frustrated and wary. In a 2016 EDHECinfra/Global Infrastructure Hub Survey of major asset owners, more than half declared that they did not trust the valuations reported by infrastructure asset managers. How, under such conditions, can the vast increases in long-term investment in infrastructure by institutional players envisaged by the G20 take place? We need transparency and accurate performance measures and the G20 data collection initiative can have a catalytic effect. With the support of the G20, the Singapore government, The Long-Term Infrastructure Investors Association, the Long-Term Investment Club and numerous private sector supporters, the EDHEC Infrastructure Institute (EDHECinfra) has now built the largest database of infrastructure investment data in the world. We can now use this data to create performance benchmarks that are needed for asset allocation, prudential regulation and the design of infrastructure investment solutions. These first …

Listed infra funds should be clearly labelled

Listed infrastructure, in its current form, cannot be called an asset class. Asset managers offering so called ‘infrastructure funds’ are misleading investors. It has been argued that the wrapper does not matter, but first impressions count. Our recent paper, The Rise of Fake Infra, reviewed the marketing material of 144 listed infrastructure products. That is, any listed fund with the word ‘infrastructure’ in its name or in the name of the index it is tracking. These funds, which account for 85% of the listed infrastructure sector by assets under management, are making claims nearly identical to private infrastructure products – offering investors “equity like returns and (sic) reduced volatility, portfolio diversification, downside protection, predictable cash flows, and predictable returns often linked to inflation, and access to a unique asset class”. An investor simply reading the marketing material might find listed and unlisted infrastructure equity products difficult to differentiate. But if you just look at what is under the wrapper, the data strongly disagrees. Listed infrastructure returns are typically below global benchmarks and are highly correlated with the stock market. They exhibit high drawdown and volatility, and risk-adjusted performance is no better than the market’s. Investors that choose to invest in listed infrastructure need to be aware of this, especially if they are expecting listed infrastructure to create diversification benefits. Our research, and others’, shows that this ‘fake infra’ does not create any new diversification benefits. First impressions do matter. Previous …

Listed infrastructure investment is a great story but it’s fake

This post was originally published in the Financial Times. For the past 15 years infrastructure investment has been the preserve of large sophisticated investors. It is rapidly becoming more mainstream, and asset owners of all sizes are considering investing in it. Originally confined to private equity or debt strategies, the label “infrastructure” can now be found on numerous financial products. We argue that not all products labelled as such are adding value to the portfolio of an institutional investor. In particular, the fast-growing listed infrastructure sector is shown by peer-reviewed academic research to offer zero additional value to an institutional portfolio. We call this fake infrastructure. Listed infrastructure is often presented as an investment that can do everything, from delivering a high Sharpe ratio, a measure of risk-adjusted returns, to hedging inflation, diversifying portfolio risk and protecting against market downturns — as well as being liquid, transparent and with a documented record. It’s a great story. Listed infrastructure products have mushroomed on the back of the newfound interest in infrastructure investment among medium to small investors. In 2006, there were nine listed infrastructure mutual funds and no listed infrastructure exchange traded funds.Ten years later, there are 66 listed infrastructure mutual funds and 32 ETFs tracking listed infrastructure indices. In 2017, 17 index providers publish more than 25 listed infrastructure indices. Combining all mutual funds and ETFs referring to listed infrastructure, we tallied more than $50bn of assets under management allocated …

Fake infra threatens real deal

This post was originally published on the top1000funds website. Support for infrastructure investment, the idea that asset owners should commit to long-term capital projects through a mix of debt and equity, is a powerful notion  at the heart of several important public and investment policy areas. It has  been much discussed. It has become a staple of high-level G20 and European Union  meetings. It has traveled from obscure trade publications to the mainstream financial  press. It has practically become fashionable. Infrastructure investment has also long been the preserve of large, sophisticated players,  because it is complex and relatively expensive, but the many smaller pension  plans and insurers increasingly find themselves unable to avoid the question: ‘Why  aren’t we investing in infrastructure yet?’ Especially now. With listed infrastructure, suddenly anyone can invest in ‘infra’. A  liquid, easy-to-understand investment proposition offers to deliver all the benefits of  private infrastructure investment without the hassle of locking up funds with a private  manager or needing your own infrastructure deal team. Even your grandparents  could do it. In fact, they do – or so they’re told. In a new Ecole des hautes Etudes Commerciales du Nord (EDHEC) position paper,  we document the dangerous rise of the so-called listed infrastructure asset class, an  ill-defined series of financial products that initially targeted retail investors and is increasingly  used by institutional investors, which now represent close to a third of the  market. Promising to deliver the benefits of …

Asset owners’ next battle

This blog was originally published on the top1000funds website. Private equity funds have long been characterised by high fees. Even as the number of asset managers (general partners or GPs) offering PE funds increased steadily over the past few decades, competition for the attention of limited partners (LPs) did not lead to an immediate shift in the cost of mandating specialist managers to buy and sell private companies. Recently however, as reported on top1000funds.com in the article Investor pressure on fees, years of pressure from asset owners has led to a seemingly ineluctable trend towards fewer and lower private equity management fees. The fact that increasing competition did not immediately lead to lower costs, when these were high to begin with, is an interesting puzzle. Economists would see a case of strong information asymmetry between buyers and sellers, combined with a case of “type pooling” – in a market where some managers are capable of delivering a high quality service at a fair price (type A) but most are not (type B), both types of manager can tend to “pool” together and offer the same low quality product at a high price. Competition fails. This common phenomenon (think “finding a good plumber”) is the result of information asymmetry: clients cannot tell beforehand which service providers are of type A or type B. Fee levels are only a consequence, or a symptom, of information asymmetry between GPs and LPs. High fees …