Q1 2021 Index Release Comment
Q1 2021 EDHECinfra Release:
A quarter of rising interest rates highlights the role of duration in infrastructure investments.
After a year which tested the resilience of infrastructure investments and their sensitivity to lower dividends in the transport sector and a higher equity risk premium across all sectors, Q1 2021 is a reminder of the role of interest rate risk in long-term investments that have “bond-like” characteristics.
As a point of reference, treasuries had the worst quarter in many years (-4.3%*) and the yield on 10-Year U.S. Treasuries, which started the year at 0.93% stood at c.1.7% at the end of March. Corporate bonds followed a similar trajectory (-3.4%*).
Likewise, private infrastructure debt exhibited higher yields at the end of the quarter than it did three months before. The average yield of the EDHECinfra broadmarket private infrastructure debt index stood at 1.88% on 31 Dec 2020 and at 2.3% on the 31st march, despite the fact that the average credit spread has remained steady at c.150bps. The index, which includes 1,000 instruments across infrastructure corporates and projects, is down -1.38% (Euro total returns) on the quarter but continues to exhibit total returns above 4% on a 3- or 5-year basis.
On the equity side, the infra300® was down -1.9% (Euro total returns) on the quarter on account of a slightly higher risk premia and an increase in yield from 8.2% to 8.8% (average across 300 constituents). The transport sector contributed the majority of the decrease, on account of both a long duration and continued Covid-related woes in the airport sector. Year-on-year a 1.45% performance is driven by a negative contribution to the index of transport and natural resources (gas) while all other sectors contribute positively to total returns. The year-on-year income return of the infra300 still stands at 7% while the year-on-year capital return is -5.5% (in Euros).
A comparison between infrastructure projects and corporates further highlights the differences in risk profile between different segments of the infrastructure universe. The expected return (or yield) of infrastructure project equity has increased by 50 basis points on average over the past year, whereas corporates have seen a rise of 80 basis points in their cost of equity. Moreover, corporates are more exposed to changes in the discount rate with a duration (sensitivity to rate changes) of about 2 years higher than project finance equity investments. In other words, for each increase in the discount rate of 1 percent, corporates make a NAV loss 2 percentage point higher than projects. Finally, their income returns are very different: the 5-year moving average cash yield of projects is now at 9% while corporates have seen their ability to distribute dividends curtailed both by high leverage and Covid-19 and their 5-year average cash yield now stands at 7.5%.
* Morningstar® US Government Bond Index and US-Core Bond Index
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