EDHECinfra Post
Infrastructure: Calling time on borrowed definitions
Publication date: 2018-12-12

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 infrastructure investments are distinctive from corporate equity or debt, all the while failing to provide a definition unique to infrastructure.

None of these classifications encompass all of the characteristics of infrastructure, from business risk profile to industrial expertise. Without this, investors continue to buy into vague strategies with no deep understanding of how infrastructure investments are concentrated in their portfolios.

What if we had a classification that embodied all the characteristics of infrastructure? The EDHEC Infrastructure Institute, as part of its work to build performance benchmarks for investors in private infrastructure debt and equity, has launched the Infrastructure Company Classification (TICCS) to do just that. Taking existing definitions and perspectives into account, EDHEC has created multi-dimensional criteria to help asset owners and asset managers classify and define the asset class. TICCS is compatible with Basel II and Solvency II definitions of infrastructure, which focus on risk profile, but incorporates the unique characteristics of infrastructure.

TICCS comprises four pillars to structure the infrastructure asset class and provide a frame of reference for asset owners and managers. It is designed to be compatible with other standard investment classifications and takes into account the evolution of the infrastructure asset class.

Infrastructure project companies are created in the context of a long-term contract between an investor and a public or private-sector client with the aim of developing a single project and their incentives to take risk are minimised by their financial structure. Infrastructure projects are highly leveraged and this plays an important disciplinary role, as well as being a signal of creditworthiness.

An infrastructure corporate, however, is akin to a traditional corporate. Managers have the freedom to make investment decisions that change materially and strategically over time. They are also free to change their financial structure and can use multiple sources of public and private financing. Debt can be used to increase returns on equity and creates incentives to take risks.

It is vital that infrastructure differentiates itself from private equity and real estate using clear definitions and structure. Without this, investors will be sold mistruths and will never truly be able to integrate infrastructure into their wider investment portfolios.

TICCS will enable investors to group infrastructure investments in a more structured way. It can define investment styles and will enable asset managers to design investment strategies that explain the characteristics of infrastructure more effectively. In turn, it can be used to define benchmarks for each strategy. And it will enable asset owners, managers, regulators, banks and advisers to structure the sector, and document the investable market for infrastructure in years to come.