Submission to the Australian Treasury
SUPPORTING RESEARCH PAPER
In this contribution to the exposure draft consultation on the “Your Future, Your Super” package, we do not comment on the general approach taken by the regulator to benchmark MySuper products but solely focus on the choice of benchmark for the unlisted infrastructure asset class. We propose abandoning the use of listed equity indices to proxy investments made in the unlisted infrastructure equity asset class in the proposed performance tests of MySuper products. We argue that recent advances in data collection and innovation in asset pricing provide a robust and academically validated alternative to the currently proposed benchmark. This listed equity index (the FTSE Developed Core Index) is wholly inadequate because it is not representative of the universe or of the risks to which Superannuation products are exposed when investing in unlisted infrastructure. Instead, the infra300, an index built to be representative of the unlisted infrastructure universe, constitutes a robust and fair alternative that can benefit plan members and managers alike as well as meeting the prudential objectives of the regulator.
In this issue of EDHECinfra Research Insights, we first discuss the surprising persistence of absolute return benchmarks in unlisted infrastructure investment. Today, absolute return benchmarks are the norm in the unlisted infrastructure investment sector, yet they are completely inadequate to understand the risk, performance and contribution of infrastructure assets to the total portfolio. The vast majority of investors agree with this assessment. We review what investors have to say about it, the reasons why these benchmarks are inadequate but also why they have tended to persist.
We establish that while long-only infrastructure investment cannot be considered an absolute return strategy (since it not market-neutral) the usual alternatives of using appraisals or listed proxies have been even worse options because they mis-represent the asset class. Absolute return benchmarks have persisted as the lesser evil.
However, recent innovations have increased the range of available choices to benchmark unlisted infrastructure. We show that that the Q1 2020 release of the EDHECinfra indices captured the impact of Covid-19 on infrastructure investment with a high degree of granularity; each sub-index capturing a different risk profile for different segments of the universe.
Leveraging this granularity, a complete analysis of the sources of risk and performance of any infrastructure portfolio can be conducted. In a second article, we use this data to better understand the performance of two peer groups of infrastructure investors: large asset managers and large asset owners.
We show that large infrastructure asset managers outperform the market and large asset owners thanks to the better asset selection skills. We also find they are not able to use asset allocation to different sectors or business risk segments to improve their performance. Instead, they often underperform the benchmark because of their implicit or de facto asset allocation choices.
Next, we summarise some of the findings of a new paper exploring whether infrastructure companies exhibit statistically significant differences from other investable assets. Controlling for variables like size, profitability, leverage, investment opportunities and industry, we show that they do indeed demonstrate unique fundamental characteristics including higher asset tangibility, asset illiquidity and inflexibility and lower operating leverage than a control sample of non-infrastructure firms.
A fourth article presents the first steps of our research program on the ESG characteristics of infrastructure companies: it highlights some of the key findings of a comprehensive review of ESG standards used in the infrastructure sector and argues that as the standardization of ESG follows its path towards consolidation, a scientific, theory-based approach to designing and implementing ESG assessments still remains to be built.
This paper argues that there is no reason for investors in unlisted infrastructure to continue using absolute return or ‘cash +’ benchmarks. It calls for investors to abandon them and adopt market-relative benchmarks based on fair value and representative data.
This change from an absolute reference to a relative one would provide a better appreciation of the risks and performance of infrastructure investments and as such would allow taking more informed investment decisions.
We note that in a recent global survey, most of the industry supported this view. In practice however, many of them still use an absolute benchmark that fails to represent the risks of their infrastructure investments.
We conducted one of the largest survey ever made of infrastructure asset owners and managers in 2019 and found that most investors use absolute benchmarks or listed infrastructure indices to determine their investment strategy, monitor performance and manage risk.
The vast majority of respondents also acknowledge major issues with their infrastructure benchmarking practices: current benchmarks are not representative, do not measure risk, do not allow investor to target or define a strategy and do not offer much information about correlations with other asset classes.
Without adequate benchmarks, the development of a global infrastructure asset class, which is one of the objectives of the G20, is necessarily limited, if not compromised.
This situation will evolve and, in all likelihood, improve with the development of the asset class. One could make comparisons with the development and gradual improvements made in other alternative asset classes that began to attract institutional investors a couple of decades ago such as real estate or hedge funds.
Long-term investment in illiquid assets creates a demand for monitoring (as the alternative to trading in and out of the asset class) and as better databases and benchmark offerings are created, growing and successful alternative asset classes like infrastructure begin to the long road towards maturity, transparency and better benchmarks.
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.
This position paper examines the results of a large survey of infrastructure investors and their preferences for the segmentation of the infrastructure asset class. Using those results, coupled with modern finance theory about what should matter to investors, this paper sets out a taxonomy of unlisted infrastructure investment indices and benchmarks that can give structure the global unlisted infrastructure asset class.
This taxonomy will now be used to compute all EDHECinfra indices, sub-indices and custom benchmarks.
– Access to Infrastructure Investment and #fakeInfra
– Is Listed Infrastructure an Asset Class?
– Private Infrastructure Equity Investment Benchmarks
– Private Infrastructure Debt Benchmarks
– The Valuation of Private Assets
– How to Derive Equity and Debt Index Results
This issue is an Infrastructure Benchmarking Special.
We first address the rise of #fakeInfra and how it has been an obstacle to the development of real infrastructure investment. There is no such thing as a “listed infrastructure asset class.” It is presented to investors as an opportunity to gain exposure to something new or rare, but has really always been available — that is, it is already “spanned” by existing capital market and other instruments.
– Towards better infrastructure investment products?
– Looking for a listed infrastructure asset class
– Is private infrastructure different?
– Tracking credit metrics in private infrastructure debt
– Data collection for infrastructure investment benchmarking
In this Special Issue of EDHECinfra Research Insights We present the result of the first in-depth survey of institutional investors’ perceptions and expectations of infrastructure investment. Almost two thirds of surveyed institutions declared that they wanted to increase their current holdings of infrastructure investments.
The survey reveals some important evolutions and also important differences of perspectives, amongst investors and also between asset owners and managers. One of the key findings is that investors have no bench- marks and do not trust reported valuations.In a short article, we then look at whether an asset class of listed infrastructure exists. We do not manage to find listed proxies for infrastructure assets. We conclude that what is typically referred to as listed infrastructure is not an asset class or a unique combination of market factors. It cannot be persistently distinguished from existing exposures in investors’ portfolios. Expecting the emergence of a new or unique “infrastructure asset class” by focusing on public equities selected on the basis of industrial sectors is unlikely to be very useful for investors.
In this paper, we present the first results of a multiyear project to create and compute fully fledged private infrastructure debt investment benchmarks. The first version of these indices span 14 European countries over 16 years, going back to 2000. They are built from a representative sample by size and vintage of the private European infrastructure debt market, including hundreds of borrowers and debt instruments over that period.
In particular, we focus on what distinguishes infrastructure debt from corporate debt. When developing this research, we used two competing views of what defines infrastructure investment:
The first one equates infrastructure investment with “project finance”¹ and echoes the June 2016 advice of the European insurance regulator (EIOPA, 2016) to the European Commission to define ”qualifying infrastructure” for the purposes of the Solvency-II directive;
The second view, also expressed during recent prudential regulatory consultations, defines infrastructure investment more broadly and proposes to include “infrastructure corporates” to the definition of qualifying infrastructure assets, effectively arguing that a number of firms – because they operate in industrial sectors corresponding to real-world infrastructure – constitute in themselves a unique asset class, with its own risk/reward profile.
This paper presents the first results of an ambitious applied research project to create and compute fully fledged private infrastructure equity investment benchmarks. The indices we created span 14 European countries over 16 years, going back to 2000. In this paper we focus on three questions:
1. How does a “broad market” index of private infrastructure equity investments perform relative to a public equity market reference index?
2. Is there a difference between the risk-adjusted performance of contracted, merchant, and regulated infrastructure, or between investing in “project finance” vehicles and “infrastructure corporates”?
3. How much diversification of investment specific risk can be achieved in portfolios of private infrastructure equity investments?
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