New indices, better benchmarks
The next generation of EDHECinfra indices is ready. Computed quarterly, they use meticulously curated private data on hundreds of companies in the 25 most active global markets. They utilise cutting-edge fair value asset pricing methods to gauge value in private infrastructure investments.
A key element in this project’s success was accurately defining the investment universe. Infrastructure may not be easily defined but infrastructure investment has to be. When we started working on this topic at EDHECInfra, we decided to base our classification on “what infrastructure investment is like” from a financial aspect, namely what drives risk. This represented a big shift away from conventional methods. These have typically focused on “what infrastructure does” from a physical perspective, such as move people or electricity from A to B.
We chose this new approach because at the heart of any investment decision lies a trade-off between risk and future value. Even in highly illiquid, opaque private markets investors make choices that reflect perceived risks and price these risks accordingly. (For more details, see our latest papers on systematic factors driving prices in unlisted infrastructure.)
Finding the right definitions and the right categories
Defining the broad risk families found in infrastructure was also a key starting point in our creation of The Infrastructure Company Classification Standard (TICCS). We needed to find a new way of slicing and dicing the universe to create our indices, but it turned out that many other professionals needed these tools too. TICCS was immediately adopted by the industry from the largest asset owners and managers to multilateral institutions and standard setters. A four-pillar taxonomy, it captures the different types of business risk, industrial activity, geo-economic exposure and corporate governance that characterise infrastructure companies.
TICCS thus provides the building blocks that define our key market segment indices. It also enables us to build custom benchmarks for investors with different strategies and exposures, both existing and new. Indeed, because of its size and illiquidity, the broad market infrastructure sector remains un-investable. Instead, asset owners and managers can gain exposure to various combinations of assets aggregated over time.
Asking the right people the right questions
Adding adequate benchmarks to the infrastructure investment process will be an important innovation. As our annual survey demonstrates, most investor use highly inadequate benchmarks and they know it.
We conducted one of the largest survey ever made of infrastructure asset owners and managers in 2019. We found that most still use absolute benchmarks or listed indices to determine investment strategy, monitor performance and manage risk.
The vast majority of them also acknowledge major issues with these benchmarking practices. Current benchmarks don’t represent the infrastructure universe or measure risk, and don’t allow investors to target or define a strategy. Moreover, they offer little information about correlations with other asset classes.
A lack of adequate benchmarks creates a major impediment to the development of a global infrastructure asset class, one of the objectives of the G20.
More transparency means more investment opportunities
The evolution of any new asset classes is a dual process. Without liquidity it’s hard to measure prices, but a lack of pricing ability stymies the investment that would create liquidity. This situation will evolve as investors look for diversification opportunities and as research providers such as ourselves create the tools that they need to assess performance. This pattern reflects the development and gradual improvements made in other alternative asset classes once they begin to attract institutional investors, such as real estate or hedge funds.
In liquid markets, it’s easy to determine prices as investors trade in and out of the asset class. Long-term investment in illiquid assets generates a need to monitor value in a different way. With better benchmarks , successful alternative asset classes like infrastructure can begin the long journey towards maturity and transparency.