In this paper sponsored by the Global Infrastructure Hub (a G20 Initiative) EDHECinfra presents the result of the first in-depth survey of institutional investors’ perceptions and expectations of infrastructure investment, and asks what next generation of investment products can better answer the needs of long-term investors in infrastructure.
With the support of:
- Close to eighty percent believe that private infrastructure is an asset class but only half thinks that listed infrastructure has distinctive characteristics;
- The majority of asset owners and managers agree that infrastructure investments derive their characteristics from their contractual, not industrial features;
- Investors disagree about expected returns: a third believes that infrastructure should be “expensive” (low yielding) while the remainder requires higher returns. Managers systematically report higher expected returns than asset owners.
- Ninety four percent of respondents declare that no usable benchmark currently exists for investors in infrastructure;
- Eighty two percent of asset owners say that the classic close-ended PE infrastructure fund is outdated and not adding value;
- Close to half of institutional investors do not trust, or do not know whether or not they can trust the valuations reported by infrastructure managers.
- Three quarters of asset owners are concerned or very concerned about the amount of dry powder accumulated in private infrastructure equity and debt mandates and how it might undermine the quality of future investments.
- A minority of asset owners declares ESG to be a first order priority, while the majority thinks that while important it is a second order problem.
A growing consensus on the definition of the infrastructure asset class
- There is wide disagreement amongst respondents about whether listed infrastructure equity or debt qualify as an asset class. However, unlisted infrastructure is widely considered to be a “unique” asset class, both on the private debt and privately-held equity sides;
- Most respondents also believe that focusing on infrastructure investment only makes sense if it can be defined as an asset class, whereas a minority reports preferring to approach infrastructure as an investable bundle of factor exposures;
- Most respondents perceive infrastructure investment’s unique feature to be either its potential for portfolio diversification or for harvesting risk premia, whereas it is less frequently believed that infrastructure has unique interest rate or inflation hedging properties;
- Investors and managers define infrastructure in terms of long-term contractual arrangements and monopoly regulation and acknowledge that industrial sectors are a much less informative way to categorise such investments. In the same spirit, the stability of long-term contracts and the role counter-party risk are perceived to be the most important and unique characteristics of infrastructure firms (compared to other firms). Finally, “brownfield” (existing) and “contracted” infrastructure is reported to be the most attractive to investors, closely followed by brownfield regulated utilities;
A range of views on the risk/return trade off of infrastructure investing
- Expected returns follow a clear pattern determined by the ”business model” (contracted, merchant or regulated) and the lifecycle (greenfield or brownfield) of infrastructure firms, with greenfield merchant investments requiring higher returns than brownfield regulated and contracted infrastructure;
- Despite viewing infrastructure as characterised by long-term stable contracts and being most attractive once it has been built, most investors and their managers expect relatively high returns. A majority considers that infrastructure assets should not be “expensive” and requires equity returns ranging from the high single digits to the low teens. Asset managers systematically report higher expected returns than asset owners.
Strong interest for emerging markets infrastructure
- More than half of participating asset owners declare investing or wanting to invest in emerging markets, and indicate willingness to increase their current allocation. SWFs and pensions plans are the most involved and willing types of investors investing or aiming to invest emerging market infrastructure;
- The main reported reasons to expand into emerging market infrastructure are higher returns and country risk diversification, while the main concerns of investors are public policy reversals and the enforceability of contractual claims.
- Required returns in emerging markets are higher but otherwise follow the same patterns as in OECD markets. However, the emerging market premium on returns varies for different types of infrastructure projects: investments in the contracted and regulated categories command much higher spreads (above the OECD required returns), particularly at the brownfield stage, whereas emerging market merchant risk is perceived to be almost equivalent to OECD merchant risk.
A degree of divergence between asset owners and managers
- The immense majority of asset owners are rather dissatisfied with existing infrastructure investment products;
- Fee levels are the first reason for this state of affairs but, in second place, the absence of well-defined investment objectives of the various infrastructure funds and platforms is another important source of dissatisfaction;
- Even co-investment alongside managers or banks is considered by almost half of asset owners to be only a second best i.e. they would rather have access to the investment products they need and want.
- The immense majority of asset owners consider the classic closed-ended private equity infrastructure fund model to be ”outdated” and ”not adding value”;
- The majority of investors also declare themselves to be concerned or very concerned by the accumulation of ”dry powder” in numerous infrastructure fund mandates, because it could lead to a deterioration of investment/underwriting standards.
Diversification and outperformance are the main objectives of asset owners today, but not the only ones.
- Most respondents concur in saying that infrastructure investment only really makes sense as a long-term strategy (beyond ten years), and a majority declares themselves willing to buy and hold infrastructure investments until maturity. Logically, but perhaps surprisingly, most investors report not being particularly concerned by the absence of liquidity of such investments.
- Most investors declare preferring investing in privately-held infrastructure debt or equity – as opposed to public stocks or bonds – but they are evenly divided between those who prefer direct investment and those who would rather delegate to a manager.
- Overall, the objectives pursued through infrastructure by the majority of investors are linked to improving diversification and achieving higher performance. Other objectives that are intuitively associated with infrastructure investing such as hedging inflation or interest rate risk are less present in the series of objectives currently being pursued. However they are amongst the highest ranked objectives that investors would like to be able to achieve through infrastructure investing (along with stable cash flows and illiquidity premia).
Current infrastructure benchmarks are either lacking or inadequate
- Investors’ current use benchmarks for their infrastructure investments are as likely to be relative or absolute, nominal or real, or relative to a market or a macroeconomic index. There is no clear market practice;
- In fact, the immense majority of investors and managers agree that currently available benchmarks are inadequate and that proper infrastructure investment benchmarks just do not exist;
- Survey respondents confirm that risk metrics in particular are not documented and that valuations are sufficiently problematic to cast doubt on any measure of returns as well. More than half of asset owners either do not trust or do not know if they can trust the valuations reported by the infrastructure asset managers.
ESG considerations matter more but remain a second-order problem for most investors
- Investors acknowledge the relevance of ESG considerations but a majority considers ESG to be a second order problem i.e. one that does not trump first order questions like strategic asset allocation;
- Nevertheless, 17 percent of owners consider ESG to be a first order question;
- Most respondents also expect ESG to be positively related to investment returns.
1 – USD2.6 trillion of pension funds; USD4.8 trillion of insurance companies; USD0.5 trillion of sovereign wealth funds (SWFs).