Written on 05 July 2018.
Earlier this month we held the first EDHECinfra Days event in London, bringing together asset owners, managers, bankers and advisors to present the EDHECinfra indices and discuss the future of infrastructure investment. We looked at the broad market benchmarks produced by EDHECinfra - covering hundreds of infrastructure companies worldwide and providing 20 years of track record - and asked the audience "Do we now have an infrastructure asset class?"
We do. But the exact perimeter of this asset class remains to be defined precisely and consensually. "What is infrastructure?" continues to be a talking point between asset owners and managers. There is a desire not to lose sight of the tangible. Speaking in the opening panel session at the event Paul Shantic, Director - Inflation Sensitive at Californian pension fund Clastrs said: “It matters that it's infrastructure. And it matters that it is defined and can be explained to someone.”
Today the industry is working with a broad, perhaps too broad, definition of infrastructure: a long term asset, stable cash flows, essential services... A definition does exist for the purpose of Solvency II, but on the whole investors talk about infrastructure in very high-level terms, and that definition differs from asset owner to manager and from manager to manager.
Because infrastructure investors need benchmarks, they also need a clear and stable definition. A more structured classification of infrastructure can take into consideration the characteristics and risks of different business models, industrial segments, corporate structures and geo-economic factors. This will be particularly important if we want to open this asset class to a wider universe of investors.
Investors at the event were also vocal about the requirement for a better measure of risk. Asset owners and managers interviewed on the side lines of the event repeatedly said that risk was not well understood in the infrastructure sector. “Investors think about return not risk,” said one.
Indeed, infrastructure investors often work with absolute return benchmarks in lieu of a better measure. But there is an overwhelming demand from investors for proper risk-adjusted benchmarks for private infrastructure debt and equity. Many asset owners said without such benchmarks they are currently "making do". A major US pension fund said that while they knew their current benchmark was imperfect (CPI plus a few hundred basis points), it is all they have. The investment professional professed that a risk-adjusted benchmark for infrastructure would make life much easier.
To add further complication listed infrastructure is often used as a proxy for private infrastructure performance. The problem is listed infrastructure indices are poorly constructed. Asset owners and managers at the event said that listed infrastructure was not a good proxy for the private market due to the constituents of listed vehicles and indices. Previous EDHECinfra research on the topic shows the current limitations of this approach.Those investors who have built benchmarks of private infrastructure investments using "listed infrastructure" proxies were also under no illusion: "we know it's wrong!" one of them reacted.
Almost inseparable from the need for risk-adjusted benchmarks was a unanimous call for better valuation models. The infrastructure industry uses valuation models inherited from the private equity and real estate sectors, inheriting their numerous limitations and adding to that lack of accounting for long-term value which is inherent in such models but also at the heart of infrastructure investment. There is a well-acknowledged lack of transparency and it can be shown that current valuation models could be easily manipulated. This was a reminder of one of the main findings of our survey of infrastructure investors (the largest ever undertaken, on behalf of the G20) which found that at least 50% of the respondents don’t trust the valuations reported by their managers. There is a demand for change. These can only be based on better methods and reporting, indices that capture risk and return characteristics, advanced private asset pricing techniques that take into account market transactions and systematic sources of risk. Significant improvements to current approaches, based on 'forward-looking views' that often amount to unrealistic guess work about the future of energy prices or the world economy over the next 25 years, are possible.
With proper benchmarks and a better understanding of the risk of infrastructure investment performance we will see the industry evolve to offer new infrastructure investment products to better meet the needs of both existing and new investors.
Mark Fawcett, CIO of NEST Corporation, one of the UK’s largest defined contribution pension schemes opened EDHECinfra Days 2018. NEST does not currently invest in infrastructure, but would like to. Mark explained that for DC funds the investment horizon of the majority of infrastructure funds is too short. And their fees are too high. For DC pension funds to get comfortable with infrastructure, evergreen funds with longer horizons are needed. This was echoed by other investors in the room. Such structures would enable investors to invest as and when they have cash flow, so they don’t have to find a new manager every time they have cash to invest. There are very few of these structures in the market today. The DC pension market is growing exponentially in the UK and if infrastructure managers want to take advantage they really need to think about new structures and certainly about fees.
The infrastructure investment landscape is evolving and the demand for more data and greater transparency in reporting the performance of investment was reiterated throughout the day. Some food for thought for some of the managers, bankers and advisors in the room as they try to keep up with the pleas of asset owners.
In 2018, EDHECinfra will publish our global index for private infrastructure debt and equity. We think that this new tool, based on solid academic research and the largest infrastructure investment database in the world, will facilitate the evolution of infrastructure as an asset class.
► EDHECinfra Days 2018 took place in London on the 7 June, with support from our research sponsors, Long-Term Infrastructure Investors Association, Natixis and Global Infrastructure Hub. Over 150 investment professionals attended the event, the first to bring together advanced quantitative techniques to the world of private, illiquid infrastructure investments.
► EDHECinfra's team of analysts and researchers presented the fundamental building blocks of asset pricing and risk modelling techniques used to create the EDHECinfra benchmarks.
► Associate Research Director and Head of Asset Pricing, Majid Hasan presented a new approach to private asset valuations explaining what’s wrong with the standard valuation and performance reporting approach. Instead he offered a valuation model that uses discount rates that reflect risk and market prices much better.
► Later Majid presented a structural model to measure credit risk in infrastructure debt. He highlighted the issues with credit risk metrics used by rating agencies and showcased a dynamic new approach to measuring expected default frequencies at the individual project level thus allowing for a better understanding of credit risk.
► Senior Analysts Sharyn Chang and Christy Tran presented the EDHECinfra broad market benchmark of unlisted infrastructure equity and Senior Analysts Silvia Garcia and Jing-Li Yim presented the latest results from the EDHECinfra broad market benchmarks of private infrastructure debt.
► Meanwhile Associate Research Director and Head of Data Collection Timothy Whittaker and Senior Analyst Christy Tran presented the actual performance and risks of listed infrastructure products in the market today asking is listed infra in its current form fake?
► Later Timothy and Senior Analyst Jing-Li Yim presented the latest findings from the annual EDHECinfra/G20 investor preferences survey. Timothy and Jing-Li explained how in this survey we revealed investors’ pricing preferences for infrastructure through contingent valuation surveys.
► Senior Analyst, Silvia Garcia and EDHECinfra Director, Frederic Blanc-Brude presented the findings of the first EDHECinfra case study. An examination of the Spanish toll roads procured between 1998 and 2018.
► To end the day Senior Research Engineer Qi Wang took a portfolio approach presenting EDHECinfra’s latest research on the role of diversification in private asset portfolios. Qi explained the issues with measuring covariance in the conventional way and proposed factor based solutions.
Investors are already looking ahead to next year’s event. Of the delegates surveyed a huge 74% said they would attend EDHECinfra Days 2019.
EDHECinfra would also like to thank its media partners, IPFA, Inframation and IPE for support with this event.