The Volatility of Unlisted Infrastructure Investments

The volatility of infrastructure equity investments is the risk which investors take to receive a reward for holding such assets. Therefore, a robust measure of risk and its drivers is an essential part of the inclusion of infrastructure investments in the portfolio, from strategic asset allocation to risk management and reporting, to manager compensation. However, measuring this risk is difficult because the only available data is often limited and typically report unrealistic total return volatility. In this paper, sponsored by the Long-Term Infrastructure Investor Association (LTIIA), we examine the drivers of the volatility of unlisted infrastructure equity investments, that is also, the reasons why the market prices of such investment can and do vary over time.

The market value of these investments is determined by the combination of expected cash flows (dividends), and a discount rate that combines a term structure of interest rates (the value of time) and a risk premia to compensate investors for the uncertainty of the future payouts. On average, the applicable market discount rate is also a reflection of investors’ expected return.

Using our approach to mark unlisted infrastructure to market, we find that the combination of changes in expected dividends (e.g. following a change in demand for transport services or energy) and of changes in expected returns lead to a level of total return volatility in the 7-12% range. The resulting risk-adjusted returns are realistic while still attractive.

Our analysis uses the EDHECinfra database of unlisted infrastructure equity investment data, which covers hundreds of companies over 20 years and a new robust approach to measure the market value of these investments over time. Thanks to this technology, which predicts actual market prices very precisely, it is possible to measure the variability of unlisted infrastructure equity prices and to describe its fundamental components.

In the paper, we conclude that with adequate and reliable measures of volatility, infrastructure can be addressed from a total portfolio perspective (strategic allocation), from a prudential perspective (e.g. Solvency-II) using methods that apply across asset classes.

Which Factors Explain Unlisted Infrastructure Asset Prices?

This paper drawn from the EDHECinfra /LTIIA Research Chair shows that common risk factors found in numerous asset classes explain the evolution of unlisted infrastructure secondary market prices. It also shows that after a long period of prices increases, “peak infra” may already be behind us.
Private infrastructure is an illiquid market and assets do not trade often. As a result, observable transaction prices are limited and are not representative of the investible market.
The paper uses actual transaction prices and advanced statistical techniques to estimate unbiased factor effects and apply these to a much larger group of companies (the EDHECinfra universe) which is built to be representative of the investable market.
Six factors are found to explain the market prices of unlisted infrastructure investments over the past 15 years; size, leverage, profits, term spread, value and growth. To these usual suspects, one can add sector and geographic effects. The result is an unbiased view of the evolution of prices (price-to-sales and price-to-earnings ratios).

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