…but can investors understand the risks?
With new data that accurately describes the yield and risks of infrastructure investments, institutional investors can embrace infrastructure investment more easily. This article was originally published by The Economist in March 2021.
Governments around the world are eyeing infrastructure as a post-Covid economic panacea. The ability of infrastructure projects to stimulate short-term employment and boost economic growth long-term have made them the cornerstone of UK, US and European ‘build back better’ Covid recovery plans.
Many of these projects will need private investment partners; and intuitional investors are looking for low correlation, high yielding alternatives to bonds and stocks, but have had trouble ramping up their allocations to unlisted infrastructure equity or debt, which remain low on average according to the OECD, with many investors still completely new to the asset class despite its likely benefits for long-term investors.
One of the reasons for this hesitance has been the paucity of available data. Investors have been at pains to benchmark unlisted infrastructure investments using inadequate listed proxies or private appraisal data that shows suspiciously low levels of risk. “Appraisal values are backward looking and as a result, do not reflect the fair value and the risk of investments as priced by markets, says Frederic Blanc-Brude, director of EDHECinfra, an infrastructure investment index provider and offshoot of EDHEC Business School.
Without updated valuations, investors find it hard to understand the yield or the risks of investing in infrastructure. This is one of the main reasons why many investors still have questions about the role of this asset class in their portfolio and why the billions of dollars of long-term investment in infrastructure politicians dream of are taking time to materialise.
Should anyone invest in airports?
The Covid lockdowns have been a reminder that infrastructure businesses do not exist in a vacuum and are exposed to common sources of economic risk. This has prompted some trustees and prudential regulators to ask difficult questions about the true value of some of these investments, especially airports, which have been popular amongst large pension plans and sovereign wealth funds.
Airports are amongst the investments most impacted by the pandemic: the EDHECinfra Unlisted Airport Equity Index is down by more than 30% for 2020, following an estimated 300 basis point increase in the equity risk premia required for such assets. “It may in fact be a good time to invest in airports, says Blanc-Brude, but only at the right price.”
However, current market prices are seldom reflected in asset values reported by infrastructure funds managers, EDHECinfra research shows. Despite airports or other transport assets having clearly lost value in 2020, managers continue to welcome new investors on the basis of historical valuations and premia computed using ad hoc hurdle rates not based on performance.
Of course, estimating the fair value of private illiquid companies is more challenging than for publicly listed investments, but International Financial Reporting Standards (IFRS) are very clear: it should be as close to comparable market prices as possible. “The fair value of private airports today should reflect their future cash flows, which have decreased but will still be paid over several decades, as well as the value of time (interest rates) and the price of risk, because these cash flows are now more uncertain than before,” says Tim Whittaker, Head of Data at EDHECinfra.
Since late 2019, EDHECinfra has been producing marked-to-market indices of the performance of several hundred investments in unlisted infrastructure equity, as well as thousands of private infrastructure loans and bonds.
One of the most used indices produced by EDHECinfra is the infra300, which tracks the performance of a representative set of private infrastructure equity investments in 22 countries for the past 20 years. Established investors such as the OECD pension plan use it to design and monitor their infrastructure investment strategy.
Using this data, newly published research shows that investors could invest as much as 10% of their portfolio in infrastructure depending on their risk appetite. “Because we measure fair value, we also measure risk and correlations with other asset classes, says Blanc-Brude. Building a better allocation to infrastructure equity or debt is now possible.”
This evolution from opacity to transparency is not unprecedented in alternative asset classes such as hedge funds and private equity, which, over the years, have become well understood, as better, more granular data and research became available.
The road ahead
Whatever the bumpy exit out of the Covid crisis, any ‘New Deal’ by large governments looks set to include a hefty slice of infrastructure projects. With them comes significant opportunities for institutional investors, but these can only be realised within portfolios that reflect the true yield and risk of this asset class. With better information becoming available, politicians can continue to hope to see these projects built.