An asset class is born

The next generation of EDHECinfra indices is ready. They are computed quarterly, use meticulously curated private data for hundreds of companies in the 25 most active markets in the world, and cutting-edge fair value asset pricing methods. A key element in this project was the definition of the universe. Infrastructure may not be easily defined but infrastructure investment has to be.  When we started working on this topic at EDHEC we decided to focus more on what “infrastructure investment is like” i.e. what drives risk and less on what “infrastructure does” (move people or electricity from A to B, etc). This is because at the heart of any financial investment decision lies the trade-off between risk and future value. Even in highly illiquid, opaque private markets, as we show in a series of new papers the systematic factors driving prices in unlisted infrastructure debt and equity, investors make choices that reflect perceived risks and price these risks accordingly. Hence, a classification of broad risk families found in infrastructure was a key starting point to the creation of The Infrastructure Company Classification Standard (TICCS). Immediately adopted by the industry from the largest asset owners and managers to multilateral institutions and standard setters, TICCS is a four-pillar taxonomy that captures the different types of business risks, industrial activity, geo-economic exposure and corporate governance that characterise infrastructure companies. TICCS thus provides the building blocks for the definition of key market segment indices but …

A factor revolution in unlisted

This blog was originally published on top1000funds.com. In this third and final article on the EDHECinfra/G20 survey of infrastructure benchmarking practices the role of infrastructure investment benchmarks for the purpose of risk management is discussed. More than 300 respondents took part in the survey, including representatives of 130 asset owners accounting for $10 trillion in assets under management, or more than 10 per cent of global AUM. Most respondents declared needing to change their current benchmarks when it comes to the risk management of their infrastructure investments. Infrastructure investment as a collection of risk factor exposures In a portfolio context, risk management aims to control and optimise the amount of risk taken by investors per unit of expected reward (excess return or spread). As such, it focuses on the sources of remunerated risk found in various securities i.e. the factors that explain and predict the price and therefore the returns of these securities. Priced risk factors are the result of fundamental economic and financial mechanisms but are usually proxied using the characteristics of investments that systematically explain or drive asset values. For instance, most asset values are impacted by movements in interest rates. But not all assets are equally exposed to interest rate risk, depending on their expected life and payouts. An important aspect of risk management for infrastructure investors then is to understand the underlying risk exposure created by a given infrastructure investment strategy or mandate. Moreover, as discussed in the …

Infra performance benchmarks wanting

This blog was first public on top1000funds.com The EDHECinfra/G20 survey of infrastructure benchmarking practices, which included representatives of 130 asset owners accounting for $10 trillion, has found that existing performance monitoring benchmarks are self-defeating for asset owners and managers. But improvement, in the form of a more representative, better defined benchmarks, may be possible thanks to recent progress. This is the second in a three-part series examining the results of the survey. Infrastructure investment requires customised performance benchmarking Performance-monitoring benchmarks differ from the asset-allocation benchmarks insofar as they should represent actual investment choices made when implementing a fund’s investment policy. In the case of infrastructure, the difference between policy and performance-monitoring benchmarks is all the more significant in that the ability to implement any given style or tilt is itself uncertain: infrastructure markets are notoriously illiquid and in part driven by public procurement and other policy decisions that are not easily predicted. The implementation of a broad policy allocation to infrastructure may take multiple incarnations: different levels of geo-economic, industrial, or business-risk exposures are likely to require dedicated sub-allocations and will be fully known only after the fact. For instance, the high degree of specialist industrial knowledge required to make investments in any infrastructure sector usually militates for individual sub-strategies or mandates. Perhaps even more importantly, building large, well-diversified positions in any segment of the unlisted-infrastructure space remains difficult today, given the average time and size of individual transactions. As a direct result, …

infra risks misunderstood

The 2019 EDHECinfra/G20 survey of infrastructure investors is a detailed study of benchmarking practices amongst asset owners and managers and brought to light a significant issue with regard to the investment process in infrastructure: investors do know how much risk they are taking and they are not happy about it.

Infrastructure prices don’t show bubble

This blog was initially published in top1000funds.com. Infrastructure equity prices do not exist in a vacuum. Analysing hundreds of transactions over the last 15 years, we found that they are driven by systematic risk factors, which can be found across asset classes. In other words, markets did process information rationally and average prices did reflect buyers’ and sellers’ views and preferences for taking risk. These risk factors (size, leverage, profit, term spread or value) are commonplace for sharemarket investors. After all, unlisted infrastructure equity is still equity. As a result, unlisted infrastructure prices have been partly correlated with public markets over the last 15 years. The price formation process happened almost in slow-motion, however, because of the illiquid nature of the unlisted infrastructure market. The raw data shows unlisted infrastructure companies such as ports, airports and merchant power, experienced a sharp drop in revenue in 2009. But unlike stocks, the effect on valuations was not immediate because few transactions took place at the time. This shock to revenues and earnings impacted transaction prices only later on. Then, in 2011, despite revenue growth being either stable or still declining, average infrastructure valuations began rising rapidly. This continued until 2016. Not all sectors peaked at the same time. For instance, the power sector started a new price decline in 2015. In contrast, airports had their highest average valuations increase in that period. By 2017, despite the return of revenue growth, average prices …

Infrastructure: Calling time on borrowed definitions

This blog was originally published in IP&E Real Assets. Infrastructure as an asset class has evolved over the past 10 years. In that evolution, it has taken classifications and definitions from private equity and real estate, such as core and core-plus. Recently asset managers have launched investment products offering value-add strategies and increasingly the line between private equity and infrastructure has blurred. The trouble with inherited labels is that they provide no clear definition of infrastructure that suits all dimensions and risk profiles of the asset class, often giving managers licence to make spurious investments. As infrastructure investment grows, the boundaries are being stretched by some asset managers investing in real estate-type assets with infrastructure value-add labels slapped on top. Investors are often confused as to what core, core-plus, value-add and super-core products encompass. Generally they are a way for managers to justify return targets. The infrastructure sector does itself a disservice without a clear structure and definition of the strategies it can offer investors. Without a proper taxonomy providing a set of criteria to define infrastructure, it is hard for asset managers to structure the solutions that investors need. So what is infrastructure? There are several definitions. The OECD and World Bank use definitions based on public policy. Meanwhile, regulators focus on what infrastructure ‘is like’ in order to qualify it under various prudential frameworks. Under Basel II and Solvency II, regulators apply definitions that try to differentiate how …

Does Europe need a new model for private roads?

Private investment in European roads is under fire once more. The typical charge against the ubiquitous motorway concessions crossing France, Italy or Spain is that, as quasi-monopolies, they have a nasty tendency to under-invest and over-charge. This assertion is taking on new meaning as road infrastructure ages, and lack of sufficient maintenance and investment could lead to new catastrophes like the Morandi bridge collapse. Populists, not only in Italy but also in the rest of Europe, have even concluded that the deaths are a direct consequence of the concessionaire’s search for the highest profits. Even though one should not overreact after the Genoa tragedy, one may ask whether the European model of private road concessions is fit for purpose. And all the more so in that the Juncker plan and other grand designs for European transport corridors envisage much more private investment in infrastructure. Is Autostrade per l’Italia a bad egg or do we need a different model to invest Europe’s long-term savings in its road network without facing the charge of low quality and excess profits? It is easy to imagine Autostrade allowing the Morandi bridge to suffer under increasing heavy vehicle traffic without taking sufficient action to maintain it, until it was too late. This bridge certainly needed to be closed and re-built, but under-investment in this kind of infrastructure asset is a more pervasive problem, driven by the regulatory framework of the European road sector. Looking at …

Three routes to maximizing infrastructure finance for development

Frédéric Blanc-Brude (Director, EDHECinfra) By promoting better standards, methods and benchmarking, development finance institutions can move the mountain that is preventing institutional capital from flowing into infrastructure. The World Bank’s initiative to maximize finance for development (MFD) aims to “find solutions to crowd in all possible sources of finance, innovation, and expertise” in order to achieve the Sustainable Development Goals (SGDs). In the case of infrastructure investment, a significant contribution to long-term sources of private finance is expected from institutional investors such as  pension plans, life insurers or sovereign wealth funds. These investors have become increasingly interested in infrastructure investment in recent years, in search for new sources of returns, diversification, duration and inflation hedging. However, they cannot be expected to make a substantial and durable contribution to the long-term financing of infrastructure if three important changes do not take place: Valuation methodologies need to improve to represent financial performance more accurately. Current valuation methodologies used in private infrastructure are wrong. 50% of the respondents of the largest survey of asset owners ever undertaken (by EDHEC on behalf of the G20) agree with this statement (1). Discounting 25 years of ‘base case’ cash flows using a single discount rate build from ad hoc risk premia assumptions, with little regard for the term structure of risk that characterizes infrastructure firms contradicts basic corporate finance textbooks. It is easy to do a lot better. Advanced private asset pricing techniques using stochastic DCF …

An industry standard for the infrastructure asset class

Sarah Tame (Associate Director and Chief Communication Officer, EDHECinfra) Today infrastructure investors use ad hoc benchmarks for unlisted infrastructure investment. We wish to establish an industry standard for the infrastructure asset class. EDHECinfra has made significant process, 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 recently conducted one of the largest surveys of infrastructure investors globally, with 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, and over half were focused solely on infrastructure equity investment, while a third seek both infrastructure equity and debt. When questioned about geographic segmentation of infrastructure the geographies of standard capital market benchmarks were the least preferred, with less than 10% of responses. Instead respondents said economic development and infrastructure investability was considered the most relevant. For debt markets the level of economic development is also the most frequently proposed segmentation across all respondents. …

Building benchmarks for infrastructure investors: a long but worthwhile journey

This blog was originally published on the World Bank’s PPP Blog Website. The Argentinian presidency of the G20 opens this month and will be marked by a focus on infrastructure investment. The G20 and OECD have already announced a wide-scale data collection initiative for the purpose of creating benchmarks of the risk-adjusted financial performance of private infrastructure debt and equity investments. It is about time. Investors hit a roadblock when investing in infrastructure. Until now none of the metrics needed by investors were documented in a robust manner, if at all, for privately held infrastructure equity or debt. This has left investors frustrated and wary. In a 2016 EDHECinfra/Global Infrastructure Hub Survey of major asset owners, more than half declared that they did not trust the valuations reported by infrastructure asset managers. How, under such conditions, can the vast increases in long-term investment in infrastructure by institutional players envisaged by the G20 take place? We need transparency and accurate performance measures and the G20 data collection initiative can have a catalytic effect. With the support of the G20, the Singapore government, The Long-Term Infrastructure Investors Association, the Long-Term Investment Club and numerous private sector supporters, the EDHEC Infrastructure Institute (EDHECinfra) has now built the largest database of infrastructure investment data in the world. We can now use this data to create performance benchmarks that are needed for asset allocation, prudential regulation and the design of infrastructure investment solutions. These first …

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