Investors face significant hurdles when measuring the performance of real infrastructure assets, with a low number of transactions per asset type and prices often kept private. It remains common global practice for investors to mark infrastructure assets to historical costs until they reach maturity, and to re-value assets once a year.
With the rising ability and willingness of Australian superannuation members to switch between funds, Australian funds have been at the forefront in developing timely valuation methods to ensure funds are transferred in a way that is open and fair, particularly with the onset of Covid-19 and Australia’s early release scheme.
But infrastructure investment index provider EDHECinfra argues much improvement is possible in the way data is collected, analysed and standardised. Frederic Blanc-Brude (pictured), director at EDHECinfra, says infrastructure investors need sophisticated data to match developments in other asset classes.
“A bit like what happened with hedge funds and real estate,” Blanc-Brude says, “over the years things become more documented, more marked-to-market. It is what is required of infrastructure now that it’s a bigger asset class and the regulators are taking a stronger interest.”
EDHECinfra measures the evolution of unlisted infrastructure equity and debt market prices and re-estimates the fair market value of each asset every month looking at a range of variables including interest rates, future cash flows and relevant secondary market transactions. Portfolio measures of risk and diversification are estimated using advanced statistical methods, making unlisted infrastructure more directly comparable to other asset classes.
Projects and corporates
Classing infrastructure assets according to different inherent factors allows investors to better estimate their performance over time and in different market cycles, Blanc-Brude says.
The TICCS infrastructure investment taxonomy created by EDHECinfra and now adopted by many investors including in Australia, classifies and allows benchmarking individual infrastructure investments according to factors like corporate structure, geo-economic exposures, business risk and industrial activity.
For example, infrastructure “projects” over 2020 had low but positive returns. These are companies purpose-created to do one project. They are usually heavily leveraged, with lenders, typically banks, that are very proactive in monitoring their development and behaviour. Projects tend to have ‘contracted’ business model.
“Corporates”, on the other hand, tend to be riskier and typically had very negative returns over 2020. These are large corporations providing infrastructure services, with much more leeway in how they behave and the level of leverage they decide to take on. They also tend to have a ‘merchant’ business model, which is more exposed to the economy and a longer life, hence higher interest rate risk.
In terms of revenue models, assets contracted on long-term revenue models such as selling power to a government, fared well through 2020. But merchant infrastructure providers which sell services to users directly – for example toll roads and airports – generally performed poorly.
“These are two key drivers that determined what happened last year,” Blanc-Brude says. “If you invested in project finance with a long-term revenue contract, you had less worry about in terms of cash flow risk, which also meant a lesser increase in risk premia and lower impact on valuations. If you invested in large corporates which were more correlated with economic activity because they collect fees from travelers or airlines or shipping companies, then you were in for a bad year, especially because their cash flows have now become more uncertain and this drives up expected returns.”
Ross Israel, head of global infrastructure at QIC, says Covid-19 has driven a major re-think on how to value infrastructure assets. The economic shock and the resultant fiscal and monetary stimulus from central banks has distorted calculations of regulated returns.
“The fiscal stimulus that is unprecedented since World War II has created a very different macro setting going forward,” Israel says.
“Interest rates are at all-time lows. Valuers are trying to extrapolate what is the long-term risk-free rate in their calculations. And they are grappling with another factor that seems to be potentially emerging which is inflation pressure around the rebound occurring, but also around disruptions to supply chain having some effect when demand re-emerges in economies as they get vaccinated.”
And this shock has emerged with the major theme of decarbonisation which is impacting all industries.
With the structure of pension industries varying greatly between jurisdictions, valuing and balancing infrastructure assets is an area that is evolving quickly, he says.
“Infrastructure is still relatively immature as an asset class,” Israel says. “The aggregation of data and the relative precision of benchmarks and performance is coming together slowly. In some of these measurements there is healthy debate about which benchmark is appropriate for which type of investor.”
Governments are keen to attract private investment and long-term capital to infrastructure projects as part of the post-Covid-19 economic recovery, and getting better data into the sector will catalyse this, Blanc-Brude says. While dry powder in infrastructure funds is increasing, the paucity of data is a major roadblock to this passing through to new commitments, he adds.
A major issue for the sector is “hurdle rates”, or the minimum return managers have to make before they can earn carry. Asset owners have rigidly set hurdle rates at around 8 per cent for years, but these rates have become out of touch with the market now that expected returns have fallen due to the impact of Covid-19.
This has the pernicious effect of forcing managers to increase leverage or invest in riskier assets that will bring a higher return, in order to meet their targets.
“Ironically, LPs who started with the position of wanting to be invested in real assets and infrastructure can end up being invested in lots of financial risk because of all the leverage,” Blanc-Brude says.
Better data would enable hurdle rates to be set based on the market level of expected returns, he says and allow investors to make better judgements about where infrastructure sits in their strategic allocations.
“Without a risk measure you can’t invest intelligently. You end up with investors who either put money in infrastructure, but can’t be sure whether it’s the right amount, or who don’t put money in in infrastructure because they can’t get the strategic allocation exercise right.”
Blanc-Brude also expresses concern about the currently proposed benchmark to be used to assess infrastructure in APRA’s future annual performance test. The proposed listed index, which was inherited from a Productivity Commission report written at a time when there were not unlisted indices, is highly biased towards corporates in the US and Canada, and is also highly correlated with the stock market “which makes no sense from the perspective of how Superannuation is allocating to infrastrcuture”.
“Australian super funds are invested in airports in the UK, windfarms in Germany and infrastructure in Australia, Blanc-Brude continues. There’s almost no geographic or sector overlap with what the index tracks and what the funds are invested in.”
QIC’s Israel says an increased regulatory interest in performance and accountability to members was driving consolidation in the industry, and this was a positive development. In effect, early release schemes create risks of inequitable switching between members and pricing unlisted assets like infrastructure one or twice a year is not a viable option anymore. With partability, the Superannuation system increasingly requires marking unlisted assets like infrastructure to market.
Unlisted real assets present a challenge in creating an open and transparent method of peer comparison, but measuring them against listed benchmarks isn’t the way to resolve this.
“The nuance is finding the right benchmark,” Israel says. “It would be perverse in infrastructure if a long duration asset class was linked to listed metrics, to the detriment of what we think are resilient investments and great ballast for an investment portfolio given the size of some super funds in Australia.