2019Q4 Index Release: Up on the Year, Down on the Quarter
Publication date: 2020-01-16
Unlisted infrastructure equity gave back some of the year’s gains in the final quarter of 2019 as rising bond yields curbed DCF valuations. Despite lower risk premia, performance was also tempered by flat average revenue growth.
The EDHECinfra Global Unlisted Equity Index fell 2.58% to 5228 points by year end, though that still represents a year-on-year gain of 14.06%. The average global infrastructure equity premium is now slightly less than 5%, down from 5.5% two years ago and 8-9% before 2012.
The 16-year duration of the index highlights the exposure of infrastructure companies to interest rate risk. After several quarters of declines, many markets saw long term rates heading upwards in Q4. Long-term UK yields climbed by some 40bp, 25bp in the US, more than 50bp in the Eurozone and 25-50bp in Australia.
Broad Market Unlisted Infrastructure Equity Index (2019Q4)
The infrastructure sectors most exposed to interest rate risk are dominated by large, long-lived corporates (TICCS-GC2). New Zealand companies also struggled, representing six out of the bottom 10 performers. Some 10 out of the bottom 20 were regulated utilities and airports.
Strong performers were supported by cash flow growth or their more robust, contracted business model (TICCS-BR1/CG1). For instance, the IH-635 Managed Lanes Project in the US showed both a steady increase in revenues, yielding Q4 returns of 1.4% (5.6% pa), reflecting the more robust performance of the contracted project segment of the market.
Merchant infrastructure companies (TICCS-BR2) experienced more varied fortunes, with airports seeing lower revenue growth (4.5% globally vs 7% two years ago). In the case of the Auckland Airport, this led to an impairment and strongly negative returns in Q4.
Other mostly merchant projects, such as independent power producers (TICCS-BR1/IC1010) and road companies (TICCS-BR1/IC6050) performed well, as their relatively higher risk premia more than compensated for higher long-term yields in many markets. Revenue growth also continues to increase in the power sector and on average now tops 2%. In the road sector, meanwhile, it is decreasing but still stands at an average of about 3% pa.
Some regulated water utilities (TICCS-BR3/IC8040) also made the list of worst performers: Affinity Water returned -3.6% in the quarter. South East Water also slumped -3.6%, primarily due to the effect of the rate increase on our DCF models. (See 2019Q4 Index Release (Erratum))
True to form, almost all the best returns in Q4 came from Emerging markets. Brazilian and Filipino companies, were amongst the top performers, aided by higher risk premia and a series of central bank rate cuts.
We also made some tweaks to the calculation of the indices in response to requests from investors. These bring them into better alignment with industry standards:
1) Model updates:
Based on consistent feedback, the debt index constituents are now incorporated at an instrument level. Each senior debt instrument is priced individually and is now a constituent in the index. This change brings EDHECinfra’s methodology into line with other debt indices in the industry. The new approach differs from previous versions when all senior debt of a company was considered as one unit of account.
2) Calculation updates:
Some of the senior debt instruments draw down over time and, hence, EDHECinfra has improved the price return calculation to reflect the outstanding principal at every point in time.
3) Data changes:
a. More observed equity transaction prices have been added to improve the accuracy of calibrating risk premiums to market prices. An extensive validation of historical transactions has also refined the quality of past data.
b. More than 200 company account have been updated in this quarter.
c. EDHECinfra has increased the coverage of observed risk-free rates in terms of maturities and countries, using government bonds wherever possible or other proxies. This has enhanced the forecast of interest rate curves at different points in time in the history, which is one of the key elements of EDHECinfra’s asset pricing approach.
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