In this paper, we present the first results of a multiyear project to create and compute fully fledged private infrastructure debt investment benchmarks. The first version of these indices span 14 European countries over 16 years, going back to 2000. They are built from a representative sample by size and vintage of the private European infrastructure debt market, including hundreds of borrowers and debt instruments over that period.
In particular, we focus on what distinguishes infrastructure debt from corporate debt. When developing this research, we used two competing views of what defines infrastructure investment:
The first one equates infrastructure investment with “project finance”¹ and echoes the June 2016 advice of the European insurance regulator (EIOPA, 2016) to the European Commission to define ”qualifying infrastructure” for the purposes of the Solvency-II directive;
The second view, also expressed during recent prudential regulatory consultations, defines infrastructure investment more broadly and proposes to include “infrastructure corporates” to the definition of qualifying infrastructure assets, effectively arguing that a number of firms – because they operate in industrial sectors corresponding to real-world infrastructure – constitute in themselves a unique asset class, with its own risk/reward profile.
With the support of:
We use the EDHECinfra database and technology to address two simple questions:
- How does a “broad market” index of private infrastructure senior debt perform against an equivalent corporate senior debt index?
- Is there a difference between the riskadjusted performance of infrastructure “project finance” debt and that of “infrastructure corporates,” and to what extent do these two subindices contribute to the performance of a broad market infrastructure debt index?
Answering these questions is instrumental to establishing the existence of an ”infrastructure debt asset class,” both from an asset-allocation and a prudential perspective, and to defining which types of instruments should qualify for a potential new bucket or prudential risk charge.
A Representative Sample of the Private Infrastructure Debt Market
Research using private data often suffers from multiple biases created by the source of data. To avoid this problem, when selecting constituents and collecting data, we take a “bottom-up” approach to identify individual firms and instruments, and to collect the relevant data from a range of public and private sources.
Thus, we avoid creating biases in the data collection by overweighting data made available by any one contributor, a common problem with studies involving privately sourced data. Here, the relevant firms and debt instruments are identified first and, in a second step, the relevant data is collected for a representative sample of the investable universe for which data can be collected.
In the investable infrastructure market identified, not all firms have outstanding senior debt provided by third party creditors (as opposed to the firm’s shareholders). Of the 400 firms used to create a private infrastructure market sample, about 300 are found to have senior term debt provided by commercial banks, private loan investors, or bond holders. Together they represent more than a thousand individual credit instruments.
Over the 15-year period of study, our market sample represents 40-50% of the outstanding face value of infrastructure debt in Europe.
Detailed financial information is collected for all firms in the market sample, from their incorporation date to year end 2016 or their date of cessation of operations.
Following the EDHECinfra template, we collect data about each firm and each debt instrument identified as part of its capital structure. Firms are also the subject of a number of events,² firms and instruments also have individual attributes,³ and they are also attached to values (see Blanc-Brude et al., 2016, for a detailed discussion).
This data is collected from multiple sources and aggregated, cross-referenced, analysed, and validated by a team of human analysts. Each firm’s data is reviewed iteratively at three different levels of validation including computer-generated and human checks.
A Fully Fledged Performance Measurement Technology
Private infrastructure debt is seldom traded, and only a limited amount of market price data is observable. Hence, the risk-adjusted performance of the senior debt of each firm in the index sample is derived by forecasting cash flows to debt holders, taking into account future scenarios of default and restructuring, and discounting them on the basis of the volatility of future payouts and available price information (including the initial value of the investment and comparable transactions taking place each year).
Once each senior debt tranche has been valued in each period, the derivation of the relevant risk-adjusted performance metrics at the asset level is straightforward. Individual assets are then combined to represent the performance of a given portfolio or index. To implement this approach, a number of building blocks are needed:
- The latest “base case” senior debt service, i.e., future principal and debt repayments, is either obtained from data contributors or estimated using information available about each senior debt instrument present in the firm’s capital structure (see section 3.2.1);
- The mean and variance of the firm’s debt service cover ratio (DSCR) are estimated for each firm in all realised periods and forecasted for the remainder of the firm’s debt maturity (see section 3.2.2);
- Firms are grouped by risk “clusters” or buckets, as a function of their free cash flow volatility and time-to-maturity in each period (see section 3.3.1);
- Credit risk is assessed for each company and future cash flows to debt holders are forecasted taking into account the impact of future defaults and restructuring scenarios (see section 3.3);
- Observed market prices (spreads) in each year are used to estimate spreads as a function of observable characteristics of firms, such as risk cluster, duration, cash flow volatility, and the estimated relation between spreads and firm characteristics is then used to obtain a mark-to-market price for each firm in that year, given each firm’s own characteristics (see section 3.3.3);
- Finally, after individual performance metrics have been obtained for each firm’s senior debt, a return covariance matrix is estimated for each reference portfolio or index (and subindex) and individual assets are aggregated following certain inclusion and rebalancing rules (see sections 3.4.1 and 3.4.2).
Three Key Indices
The three indices described below cover the 2000-2016 period and are defined thus:
- A broad market infrastructure debt index, covering 14 European countries and six industrial sector groups, includes 216 “live” borrowers of infrastructure debt in 2016, or 867 senior debt instruments, with a capitalisation of EUR106.1bn. Over the period, 298 borrowers are included in the index, representing 1,089 individual debt instruments;
- A private infrastructure project debt index for the same geography including 160 live borrowers in 2016 for a capitalisation of EUR48.7Bn, or 415 instruments. This index has included as many as 219 borrowers, representing as many as 544 senior debt instruments;
- An infrastructure corporate debt index also covering Europe, with a EUR57.4Bn capitalisation in 2016 for 56 live borrowers, corresponding to 447 senior debt instruments. Historically, the index has included as many as 79 borrowers representing 545 debt instruments.
Index constituents may have been removed from the “live” index because they have reached a maximum maturity or minimum time-to-maturity or size threshold, because the debt was prepaid, the borrower liquidated, or the debt sold following an event of restructuring. Events of debt refinancing or successful restructuring (workouts) lead to the creation of new instruments and the removal of the ones they replace from the index.
Index constituents can be broken down by infrastructure “business model,” instrument currency, country of origin, industrial sector, or corporate structure.
Figure 1 shows the composition of the broad market infrastructure debt index on a value-weighted basis.
Infrastructure Debt Is Unique
The following stylised facts about the risk-adjusted performance of private infrastructure debt can be drawn from our results. The broad European market infrastructure debt index (including project and infrastructure corporate debt)…
- …significantly outperforms the European corporate bond debt index over the 2000-2016 period, thanks to a significant yield spread;
- On a value-weighted basis, the broad market infrastructure debt index exhibits significant concentration, and its Sharpe ratio or risk-adjusted performance is not significantly different from that of the corporate bond index;
- However, the broad market infrastructure debt index exhibits higher risk-adjusted performance on an equally weighted basis when its level of concentration is equivalent to that of the corporate bond index;
- The duration and value-at-risk of our broad market index are higher than the public senior corporate bond reference index, justifying higher returns but also exhibiting converging tendencies over the period. The European broad market senior infrastructure index clearly behaves differently than its senior corporate bond comparator, but the difference on a risk-adjusted basis is not always very “clean.” Examining the behaviour of the two sub-indices that make-up this broad-market measure allows a more granular understanding.
But Project Finance and Infrastructure Corporate Debt Are Different
The infrastructure project finance senior debt index…
- …does not deliver a better cumulative outperformance than the broad market infrastructure debt index over the entire period;
- Still, its yield spread is higher than the broad infrastructure debt market’s after 2006, and project finance debt has been the best performer at the 10-year horizon or lower by a substantial margin;
- On a risk-adjusted basis, for either value or equally weighted portfolios, project finance debt improves on the corporate bond index by 30-60 basis points (per unit of risk) at different horizons;
- Duration and value-at-risk are consistently higher than the corporate debt index by a relatively small and decreasing margin over the period;
- In terms of return volatility, the project finance debt index has the lowest risk profile.
Finally, the infrastructure corporates senior debt index…
- …delivers a better cumulative performance than corporate bonds or project finance debt over the 16-year period primarily due to higher returns in earlier years;
- After 2006 its yield spread is much lower than that of project finance debt, even though it bounces back in 2013;
- Critically, on a risk-adjusted basis, even looking at the more diversified equally weighted index, infrastructure corporates fails to deliver a Sharpe ratio that improves on that of the listed corporate bond reference index, that is, infrastructure corporate debt may have higher returns but it also is much more volatile both than corporate bonds and project finance debt;
- European infrastructure corporates have the highest value-at-risk of the different indices considered. Table 1 provides an overview of these findings. We conclude that while infrastructure project finance debt has a unique risk-reward profile, infrastructure corporates probably cannot qualify as a new asset class. With a Sharpe ratio that cannot be distinguished from that of the public senior corporate bond market reference, infrastructure corporates are a higher-risk/ higher-return subset of the senior corporate bond bucket.
In conclusion, looking at 16 years of data for 14 European countries, a private infrastructure senior debt index exhibits investment characteristics that set it clearly apart from a senior corporate debt index. However, this broad market infrastructure debt index is composed of two subgroups of assets that have different profiles: the first one, infrastructure project finance, has a unique risk/reward profile and offers a relatively high reward per unit of risk, especially since 2007; the second one, infrastructure corporate debt, is a higher-risk/ higher-return version of the corporate debt market, but it does not offer a better level of risk-adjusted performance than corporate debt.
1 – i.e., the debt instruments used to finance project-specific firms that are expected to operate within very strict constraints over the life of a single investment project (e.g., a toll road or a power plant).
2 – E.g., incorporation, construction start and completion, operational phases start, defaults, refinancing and restructuring, prepayments, end of investment life, etc.
3 – E.g., for firms, business model, type of regulation, contracted or index nature of inputs and outputs, etc.; for instruments, seniority, currency, repayment profiles, interest rates, maturity date, etc.