This Citywire Switzerland article was written by Mark Ebert, manager of Geneva-based asset manager QUAERO Capital’s Infrastructure Strategy.
Investing in infrastructure is receiving more attention than ever before. Catalysts include plans world-wide for massive public-sector spending on neglected infrastructure, such as the US$1 trillion proposed by the US administration.
And, according to the World Economic Forum (2017), the requirement for US$1 trillion in annual renewable energy investment by 2030 to limit global warming to two degrees.
A consequence has been an endless stream of new alternative investment vehicles focussed on a wide variety of formats for investing in infrastructure.
Common beliefs and misconceptions
The ‘infrastructure investment narrative’ commonly includes the following beliefs:
- Infrastructure has lower exposure to the business cycle, due to the low-price elasticity of its services.
- Its valuation is predominately determined by income streams extending far into the future.
- Therefore, the sector should be less impacted by current events. This creates diversification benefits due to low correlation with other asset classes and protection in difficult markets.
According to Cohen and Steers (2017), listed infrastructure investments have returned 10.1% p.a. from 2006–2017, with annualised volatility of 15.5%, whilst private infrastructure has returned 8% p.a. with volatility of 8.5%.
Unlike the listed market’s real-time auction pricing, the artificial smoothing associated with infrequent private infrastructure valuations reduces volatility and correlation to produce equity-like returns with bond-like volatility.
These comparisons are misleading: there is no reason why investors should receive extra credit for not marking their positions to market.
Risk and correlation should be understood as a function of the underlying assets, not the structure of the fund vehicle, and it is likely that the risk adjusted returns of listed and private infrastructure are broadly similar.
Infrastructure - an asset class?
Real assets such as infrastructure typically perform well both in periods of high and low inflation.
However, in periods of unexpected inflation, stocks and bonds typically perform negatively, private infrastructure has been flat, whilst quoted infrastructure demonstrates a high beta to inflation, in a similar manner to commodities.
A recent study by the EDHEC Infrastructure Institute (June 2016) examined whether listed infrastructure stocks have the potential to create diversification benefits.
Using an asset class mean-variance spanning test, both pre- and post-GFC, they compared 22 listed infrastructure portfolio proxies, including 10 stock portfolios, 11 indices and one PFI portfolio.
They concluded that listed infrastructure is not an asset class or a unique combination of market factors and that asset selection schemes based on selecting stocks from infrastructure sub-sectors do not create diversification benefits.
The exception was the PFI portfolio, which is probably due to the unique business model of these assets. They involve long-term contracts with the public sector to build, maintain and operate public infrastructure facilities according to agreed output specifications, and often there are adjustments to reflect changes in price indexes.
Their cash flows are highly predictable, uncorrelated with markets and the business cycle, and highly correlated with price indexes. In effect, they do not represent a specific 'asset class'.
Analogous business models with similar diversification potential can be found in a few transportation, energy, communications, and water concession holders, but certainly not all.
Listed vs private
A balanced approach between listed and private infrastructure may be the most favourable strategy.
Investing in listed infrastructure securities with highly predictable cash flows should achieve a core exposure with portfolio diversification benefits, whilst an equal allocation to private infrastructure provides features of control, vintage selection and access to more concentrated or opportunistic investments.