What’s next for infrastructure assets after a rough Q1?
BY Yaelle Gang | June 8, 2020
With the coronavirus-induced shutdown causing ripples in public and private markets alike, infrastructure assets took a hit in the first quarter of 2020 — and the worst may still be coming.
According to data from the EDHEC Infrastructure Institute, infrastructure assets experienced a sharp drop in returns in the quarter. The decline was driven by a significant downward revision of cash-flow forecasts on a number of companies impacted by the lockdown, an increase in risk premia and lower interest rates, says Frederic Blanc-Brude, chief executive officer at Scientific Infra and director of the EDHEC Infrastructure Institute.
The quarter saw a total return of negative 6.37 for EDHEC’s infra300 index, which is built to be representative of the universe it tracks. Meanwhile, its contracted infrastructure index returned negative five per cent, its airport companies index returned negative 10.10 per cent and its merchant infrastructure and merchant road companies indices returned negative 9.62 per cent and negative 13.54 per cent, respectively. In slightly better shape, the EDHEC’s wind powers company index returned negative 2.64 per cent.
The hardest-hit assets in the quarter were GDP-linked assets with revenues that depend on usage levels, says Nathalie Proteau, associate partner and head of investment strategy for asset and risk management at Morneau Shepell Ltd.
And although it was a rough quarter, the full impact of the crisis has yet to be reflected, Proteau adds, because midstream businesses with high leverage and volume risk will possibly be even more affected going forward. Further, companies that benefit from contracts with minimum volume guarantees might be impacted by the solvency of their counterparties. And rising income pressures could threaten household’s ability or willingness to pay for essential services.
Blanc-Brude expects cash flows will be negatively impacted for many more types of infrastructure assets going forward because, initially, the lockdown pushed revenues down and a recession could follow, which would have wider implications.
Further, when looking back to the global financial crisis, the hit on infrastructure was worse than seen in the first quarter of 2020, he adds. Back in 2009, infrastructure companies weren’t directly impacted; rather, the hit was driven by a broader recession and the subsequent impact on operations. “In 2009 you had a financial crisis which triggered a very sharp increase in risk premia. This is why the performance was very bad, because the risk premia went through the roof.”
In the coronavirus crisis, the financial crisis isn’t compounding the real economy; a crisis in the real economy is gradually contaminating financial markets, Blanc-Brude says. “We started with the lower cash flows, we started with a direct hit to the infrastructure companies almost before any other business was impacted. Infrastructure companies are on the front line, so to speak, because of the lockdown and they may well be impacted even more later . . . by the impact of the recession.”
Proteau says her pension plans clients that are already invested in infrastructure aren’t making changes in response to the current situation because their investment strategies were designed based on long-term expectations. Plus, if the low interest rate environment persists, plan sponsors will be searching for yield outside of fixed income, which infrastructure can provide, she adds.
On the other hand, plan sponsors that were looking to allocate to infrastructure and were in the process of selecting managers have pressed pause. “For clients who are not yet invested, they are waiting. They’re waiting before actually committing to the manager, they’re waiting to see how markets stabilize, they’re waiting to have a better understanding of the full impact, not only on managers’ portfolios, but also on the managers because this could also have an impact on their financial soundness.”
Proteau advises plan sponsors considering their investment strategies to look for diversification of risk and of revenue and take liquidity into account. She also urges them to take a long-term view.
And Blanc-Brude says the drawdown in infrastructure may be an eye-opener to some institutional investors about the asset class’ risks, which were always present. Now, he notes, the risks are impossible to ignore. “I think it’s forcing people to recognize that they should be thinking about the risks and they should be measuring the risks, which until now they were not too focused on.”
Previously, the focus was on performance since the last decade was a strong one for infrastructure, but that time is over, he adds. “Because the limits of these assets, of their value, has been acknowledged, and now it’s perhaps more important to understand the return, but also the risk and the drivers of returns.”