Evolution of unlisted infrastructure investments and the way forward
Infrastructure assets can help diversify investor portfolios for the better – and thanks to progress in the data available, it is now easier to price and benchmark these assets.
Diversification is at the heart of an investors’ quest to create portfolios that minimise risk and maximise returns. That’s why many are attracted to the idea of adding unlisted infrastructure assets – they have a solid risk and return profile, have historically delivered high cash yield, and represent a low correlation, high yielding alternatives to bonds and stocks. But there has traditionally been a big hurdle: such assets are tough to price, especially in today’s mark-to-market world. Institutional investors and managers are generally required to value their assets on a mark-to-market basis, which means basing their assessment of value on the current market price of the asset - or the price for similar assets. That’s not easy when there is no exchange on which such assets trade (because they are unlisted) and when there are few trades happening in similar assets. This is the major reason why pension plans and insurers have been slow to build significant allocations.
Policymakers are placing large bets on the potential of institutional investors role in closing the infrastructure financing gap. According to an OECD survey, the largest 100 pension funds invest just 1.3% of their assets in infrastructure equity on average and have almost no exposure to private infrastructure debt. In effect, many investors are still completely new to the asset class despite its likely benefits. Equity and debt performance show that infrastructure as an asset class provides attractive and resilient returns for investors and unlisted infrastructure equities generated the highest returns and risk-adjusted returns. Infrastructure also has properties as an inflation hedge – something that many investors are considering given highly volatile inflation globally in recent years. Recent research by EDHECinfra suggests that investors could usefully invest as much as 10% of their portfolio to infrastructure equity or debt (see chart below).
Source: Noël Amenc, Frédéric Blanc-Brude and Abhishek Gupta (2021)
Lack of data has been a key problem for investors
One of the main reasons for investors’ hesitance has been the lack of usable data. In 2019 EDHEC partnered with GI Hub to conduct one of the largest survey ever made of infrastructure asset owners and managers. The vast majority of survey respondents acknowledged that the data available was not representative, did not measure risk, and did not allow investors to target or define a strategy.
Due to the lack of available data, investors have benchmarked unlisted infrastructure investments using inadequate listed proxies or private appraisal data that shows suspiciously low levels of risk. Appraisal values are backwards-looking and, as a result, do not reflect the fair value and the risk of investments as priced by markets. Without updated valuations, investors find it hard to understand the yield or the risks of investing in infrastructure.
So do prudential regulators who have launched inquiries into the treatment of infrastructure investments in financial regulations and the impact of COVID-19 lockdowns on infrastructure investments. Unfortunately, data collection and asset pricing in illiquid markets represents a significant challenge.
But progress on data has been made
Over time, there has been progress in the availability of data to track performance of infrastructure as an asset class at a global, regional and sectoral level, particularly for liquid assets.
For illiquid markets there are more challenges but thanks to advances in data collection and asset pricing the data gap has been addressed. EDHECinfra has produced unique 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 is the infra300, which tracks the performance of a representative set of 300 unlisted private infrastructure equity investments in 22 countries. This type of data is helpful for investors and managers to design and monitor their infrastructure investment strategy. The infraMetrics Unlisted Infrastructure Debt Indices include the infraDebt300™ and infraDebt100™ indices that represent the performance of debt instruments issued by unlisted infrastructure borrowers and can help enable investors to price unlisted debt in a reliable and consistent manner.
Strong opportunities for unlisted infrastructure
Once investors have high quality data on the unlisted infrastructure assets class, they can analyse effectively in order to make allocation decisions or benchmark their multi-asset portfolio, in the same way as they already do for investments such as equity, bonds or real estate.
For conservative investors already largely invested in bonds, adding private infrastructure debt to the portfolio can meaningfully lower the cost of hedging liabilities thanks to the higher yield of infrastructure debt, while also improving the risk-adjusted performance of the entire portfolio. Likewise, a more aggressive investor with a focus on seeking performance would benefit most from investing in unlisted infrastructure equity and, with the optimal weights, would allocate one tenth of its portfolio to this asset class (see chart above).
New infrastructure investment programs create significant opportunities for institutional investors, but these can only be realised within portfolios that reflect the true yield and risk of this asset class. regulations and risk management for infrastructure investments could be accurate with a more widespread use of this data by investors and regulators. Precise data would enable regulators to establish infrastructure as an asset class in financial regulations by introducing risk sensitivities and reducing regulatory capital charges in line with the performance of infrastructure investments. This would generate better outcomes for investors and help governments realise more investor participation in the financing of long-term growth.
Private investment in unlisted infrastructure equity and debt could be many times larger than they currently are, especially for institutional investors, and provide meaningful support to the COVID-19 recovery plans. Unlisted infrastructure creates genuine benefits within the portfolio and fortunately there is more data and better definitions available to evidence this.