A first look at the performance of unlisted equity and private debt after a year of Covid-19.
2020 was a reminder that economic shocks can impact the bottom line of many infrastructure companies, which may also lead to solvency issues in some sectors. It was also a test of the resilience of the asset class. Above all, it was a reminder that asset valuations eventually have to reflect market prices, that is, the value implied by the risks taken by investors.
The latest estimates by EDHECinfra of the fair market value of hundreds of private infrastructure investments, derived from the latest company-level data and realised transaction prices, suggest that different infrastructure industrial segments and business models performed very differently. Investors exposed to infrastructure project finance weathered the Covid crisis well. However, investors in large infrastructure corporates, especially in the transportation sector, are likely to have booked significant losses in their infrastructure portfolio in 2020. While the value of infrastructure assets largely depends on common factors, each segment possesses different exposures to these factors.
After a positive Q4 2020 with a 3.04% total return (in local currency), the infra300 index, which tracks a global sample of unlisted infrastructure equity investments worth approximately USD180bn, finished 2020 down -4.7%, combining an estimated -12.6% drop in capital value with a +7.9% estimated cash yield, year-on-year.
During 2020, the market valuations of unlisted infrastructure companies suffered from the combined impact of lower cash flows due to Covid-19 lockdowns and the ensuing economic shock and a higher unlisted infrastructure equity risk premium (+150bp year-on-year for the infra300). The decrease in interest rates, already at record lows, only provided limited relief to asset prices.
Not all transport investments did badly
There is a marked divergence in the impact of Covid-19 on infrastructure corporates, dominated by large transport and utilities companies, and that of infrastructure projects. The EDHECinfra project finance SPV index, which tracks more than 400 live project companies (500 over the past 20 years), finished the year up 2.1% on a year-on-year basis, with a solid 3.6% quarterly total return in Q4 2020. On a 5-year basis, infrastructure projects show strong returns of 10.3% per annum, with 8.5-9% volatility and a one-year, 99.5% VaR below 15%.
This contrasts with ‘corporates.’ Despite a positive Q4 2020 (+1.3%) the index for this segment which tracks 125 unlisted infrastructure companies globally is down -13.5% on a year-on-year basis at the end of 2020. Despite a cash yield of 8.1%, capital returns are -21.6% for the year. This is even worse than what this segment of the infrastructure asset class went through during the GFC in terms of maximum drawdown.
These losses in the infrastructure corporate segment are largely the result of the negative performance of the airport sector: the airport sub-index is down -35% year-on-year, including -9.5% quarterly total return in Q4 2020. This dismal performance is due to increasingly degraded future cash flows and a sharp increase in the estimated equity risk premia of these companies, which now have largely negative profits, causing the average equity risk premia in the EDHECinfra airport index to jump from around 400bp in Q4 2019 to more than 750bp at the end of 2020.
However, other corporates like network utilities, despite negative returns for the year 2020 (-6.2%), are back to positive returns in Q4 2020 thanks to no significant changes in their equity risk premia since Q3 2020 and the firms maintaining a strong cash yield.
The roads sector finishes the year with a robust 6.3% total return including a 5.1% quarterly return on Q4 2020. The EDHECinfra road index tracks the performance of 111 road investments in 16 countries. The constituents experienced an average increase in equity risk premia, in Q1 and Q2 2020, but asset values were supported by larger decreases in interest rates in some countries and the protection of their revenues by the contracted nature of their business model in 50% of cases. In merchant roads, while revenues decreased temporarily the impact on future dividends and profits was much more muted than in other transport sectors.
Infrastructure debt performs as expected
Meanwhile, the private infrastructure debt market has not seen the same impact from Covid. The EDHECinfra Broad market private debt infrastructure index, which tracks 1,034 instruments representing US$250bn of value, delivered a 6% total return year-on-year, improving on its 3 to 5-year performance by 50bp, and returning 1.2% on the quarter on account of lower rates and stable credit spreads.
Project finance debt continues to outperform corporate infrastructure debt on a 5 to 10-year basis having delivered 4.9% returns in 2020, but with lower risk and higher spreads (+50bp on average) than infrastructure corporate debt. Still, EDHECinfra credit risk models show an increase in expected loss over the past 4 quarters for corporate infrastructure debt of more than 55bp on average (150bp in the 90th percentile of the EL distribution), while the average expected loss increased by 30bp for project debt on average (but by more than 250bp in the 90th percentile).
Infrastructure remains the same in 2021
Going forward, most infrastructure companies can be expected to revert towards their long-term revenue growth path, with the exception of airports, which now face a more radical level of uncertainty and may in some cases be led to defaults or declare bankruptcy.
But investors should not return to complacent valuations: as well as future cash flows, the fair value of unlisted assets is largely driven by market movements in the discount rates: infrastructure investments are sensitive to changes in the term structure of interest rates and, since these future cash flows are uncertain, they carry a risk premium which also changes over time.
An important lesson of Covid for long-term investors was that even ‘hold-to-maturity’ investors could not afford to keep stale valuations on their books in the face of an obvious economic shock directly impacting certain infrastructure businesses. As bankruptcy looms in the airport sector, it has become clearer that recognising market risks and the variance of unlisted asset prices has clear benefits for investors: performance can be related to risks taken and benchmarked meaningfully.
For instance, the volatility of returns, the maximum drawdown and the value-at-risk for airports have been amongst the highest of the sub-indices computed by EDHECinfra. Historical returns were also high in part because valuations had increased almost continuously since 2009. On this basis, it was possible to invest in airports and understand and manage the risks taken. While Covid-19 is an exceptional event, asset values are precisely meant to capture the uncertainty of business outcomes. With a higher market risk premium and lower future cash flows, the returns on airports have now become more uncertain than they once were, but they were always risky.
Ultimately, how bad this past year was for infrastructure investors depends on whether the asset class played its role in the portfolio, as a diversifier, a source of yield or as part of a liability hedging strategy. Many infrastructure investments provided the expected relative stability and limited drawdown while still delivering an attractive cash yield. Others proved to be largely exposed to a sudden stop in the real economy, but despite the solvency issues they may be facing, they also continue to represent significant present value. A key question for investors now is to know how much.
Note: All reported data is for equally weighted indices expressed in local current total returns
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