Bridging the knowledge gap on listed infrastructure
October 28, 2019
The rush to alternative assets among institutional investors is well-documented. Within this movement, allocations to infrastructure are becoming common. The promise is attractive: returns in excess of fixed income with lower volatility than equities and a natural inflation hedge due to the characteristics of the underlying assets. Intuitively this makes sense. Infrastructure assets are generally long-lived and feature the stability of regulated or contracted revenues as well as strong margins supported by high barriers to entry for the sector. But has infrastructure actually produced the expected benefits for institutional investors? A closer look is warranted.
First, some definitions: Listed infrastructure investing is generally focused on the publicly-traded equity of companies that participate in the construction and operation of infrastructure assets. Private infrastructure investing, on the other hand, offers exposure to these companies’ privately-owned peers as well as to the actual projects themselves.
Sub-sectors within infrastructure include core, value-add and opportunistic assets. Core assets, characterized by greater return certainty, generally are already fully constructed and typically feature a long-term contract in place that may also have inflation adjustments built into it. Core assets offer lower returns with a larger return component provided via income yields and are commonly available via listed investment as well as closed and open-end funds.
Value-add infrastructure differs from core because contracts may be either short or long-term, there may be construction risk involved and the assets are more operationally complex, providing a potential benefit via active management.
And, opportunistic assets have the most return uncertainty. These may be greenfield projects with significant exposure to revenue risk via fluctuating demand and there is often no inflation protection. Opportunistic assets typically provide significantly higher return potential with a bias towards capital appreciation but are generally only available via private closed-end funds.
The return profile of infrastructure can be significantly different depending the approach taken.
Here, I’ll focus on listed infrastructure.
A listed approach is likely to result in greater exposure to equity beta and may offer suppressed returns compared to a private approach because listed strategies are more widely available and the illiquidity premium is lower. This being said, listed infrastructure features significantly more robust return data and is not subject to the same valuation and performance measurement issues we see in private approaches.
The higher return potential of listed infrastructure equity is borne out in long-term data, with the total return of the FTSE global developed core infrastructure index slightly outpacing the MSCI world index for the period from January 1990 to December 2017, according to a report by Vanguard Research. Using rolling five-year standard deviation as a risk proxy over this period, infrastructure performed attractively as well, with the noted infrastructure index exhibiting lower volatility than the MSCI world index for the entirety of the period, though the volatility was routinely closer to that of global equities than global bonds. And, listed infrastructure equity exhibited a moderate-to-high correlation to global equities (generally between 0.4 and 0.8) with a low correlation to global bonds.
In terms of infrastructure as a hedge against inflation, the data does not necessarily support this claim. As per the Vanguard research, a regression of infrastructure returns versus both changes in inflation as well as the absolute level of inflation shows that infrastructure provided no material benefit versus global equities and global REITs in terms of an inflation hedge.
This said, one wouldn’t necessarily expect a blended index of publicly-traded infrastructure equity securities to offer substantial benefits in this area. It would be reasonable to conclude that increased equity beta may dilute inflation hedge potential. Additionally, in my opinion, any underlying investment by these companies in non-core (and often non-inflation protected) projects would not aid significantly either.
These factors considered, on a historical basis, listed infrastructure has been an attractive proposition for investors looking for a suitable complement to global equities and fixed income while avoiding the illiquidity, appraisal complexities and higher costs associated with private infrastructure.