From ad hoc to world class
Today infrastructure investors use ad hoc benchmarks for unlisted infrastructure investment. They know that’ snot good enough. At EDHECinfra, we are establishing an industry standard for the infrastructure asset class.
And we’ve made significant process. We are 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 asked investors and asset managers what they want
We recently conducted one of the largest surveys of infrastructure investors globally. The survey polled 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. More than half were focused solely on infrastructure equity investment, while a third targeted both infrastructure equity and debt.
When questioned about geographic segmentation, respondents least favoured the standard capital market benchmarks, with fewer than 10% of responses positive towards them. Instead respondents said economic development and infrastructure investability was the most relevant. For debt markets, the level of economic development scored the most positively with respondents. As a result the reference market indices for infrastructure should follow broad economic development lines.
In regards to sector segmentation we found that infrastructure investors’ preferred both broad and sector specific segmentation. This is an indication of the infancy of the asset class. The results suggest that access to a well-defined asset class remains limited amongst investors who prefer to focus on sub-segments. However large managers and asset owners who wish to gain exposure to infrastructure investments across multiple sectors say that only widely defined sector indices make sense.
The classification system they have isn’t the one they need
The lack of adequate performance data until now has made it difficult for investors to take a strategic asset allocation view of infrastructure. Ultimately until we better understand the performance of infrastructure, it cannot exist as an asset class in a multi-asset class context.
Infrastructure investment is still typically segmented by industrial sector. However, we argue that business models (contracted, merchant and regulated) offer a more relevant way of grouping investments together. This is especially the case when considering business risk. For example Gatwick Airport, a regulated asset, has more in common with Anglian Water in terms of risk profile than Munich Airport, which operates under a merchant business model. When asked about making a distinction between business models, 90% of respondents saw this method of segment infrastructure investments as relevant or highly relevant.
There is no clear taxonomy
The difference between projects and corporates is another distinction worth making and is as relevant as that between business models. EDHECinfra’s research shows it is projects, rather than corporates, that offer investors the benefits of the “infrastructure investment narrative” of equity-like returns, with reduced volatility and predictable cash flows. Infrastructure projects tend to offer a relatively lower risk business model. They are also usually smaller than an infrastructure corporate. As a result indices built with infrastructure projects tend to diversify better and faster and this means higher returns and lower portfolio risk measures.
Investors’ views were split between the two however:
- 37% favour project finance specific benchmarks
- 42% would rather use benchmarks with projects and corporates
- 20% would prefer an infrastructure corporates-only index
These differences echo the different interpretations of what it means to invest in infrastructure.
And that’s the case with debt too
Finally we asked infrastructure debt investors whether it is useful to create infrastructure debt indices by maturity and level of credit risk. These are standard components of fixed income benchmarks, portfolios and products. Respondents were almost unanimous in the need to bucket infrastructure debt by credit risk and maturity.
Using the results of this survey, EDHECinfra is putting forward a taxonomy of unlisted infrastructure investment indices and benchmarks. We aim to represent the global infrastructure asset class in the ways that investors said would be most useful.
So we are solving the problem
We created eight broad market indices to provide a global view of the asset class, and respond to investors’ requirements at the asset allocation level. A number of sub-market indices also allow investors to monitor the risk-adjusted performance of particular strategies. (See table)
These broad market indices capture the systematic dimensions of infrastructure investment. Two universes (debt and equity) can be divided into broad areas of economic development or by types of corporate structure. The thematic sub-indices (business risk, sector groups, credit risk) represent specific risk profiles. With these sub-indices investors can track the risk adjusted performance of almost any specialised manager or dedicated account focused on a sub-segment of the infrastructure market. Finally infrastructure investors will have the tools to adequately measure the risk adjusted performance of infrastructure.
We can begin to see the development of a distinct infrastructure asset class.