During the early stages of Covid-19, big funds including Australian Super, UniSuper and Hostplus made blanket cuts to their infrastructure valuations, raising new issues around liquidity risk for the superannuation industry.
With private assets utilising appraisal-based valuations conducted infrequently, and assets held at their most recent valuation between these appraisals, asset prices can be many months out of date at the time of redemption by switching or exiting investors. If the asset price has fallen, remaining members are effectively subsidising those less loyal.
While Covid-19’s impact on assets such as airports has brought the issue to the forefront, valuation of infrastructure assets has gained focus in recent years as they make up a rising share of superannuation funds’ portfolios, says Frederic Blanc-Brude, director at infrastructure analytics index provider EDHEC Infrastructure. Value swings are no longer a rounding error in portfolios where infrastructure can represent a significant allocation.
“At the moment, private assets are valued maybe once a year, and there are important issues with the way it’s done,” Blanc-Brude says. “There’s quarterly reporting, but if you look at the data and available research, it shows there is significant seasonality. You have MySuper accounts which have five or ten per cent infrastructure, so it can make a big difference.”
Assets need to be valued in a way that reflects their volatility and risk, Blanc-Brude says, and Covid-19 revealed starkly a shortfall in this area.
“You need to understand the size of your allocation in order to decide how to invest across assets,” Blanc-Brude says. “when arbitraging between asset classes, are you allocating 10 per cent to infrastructure, or is it 7 per cent or 12 per cent? Understanding fair value is important.”
Understanding risk is also important due to the fiduciary responsibility to understand and report the level of risk of Super funds, he says, as well as giving accurate assessments to members about the current value of their savings.
The challenge of valuing infrastructure
This of course is no simple task. Valuing infrastructure assets and marking them to market involves looking at the latest market conditions, and doing this monthly or quarterly is a big ask for funds that hold assets all over the world, each at the mercy of changes to local economic conditions such as interest rates, inflation and other factors material to considerations of risk.
Michael E. Drew, Professor of Finance at Griffith University, says unlisted infrastructure is typically valued quarterly, and in “unexceptional market conditions” the standard practice is for independent external valuations on infrastructure assets to be conducted at least annually.
Many large asset owners in Australia promptly revalued their assets during the disruption caused by Covid-19. But shocks are only one of numerous risks that can affect infrastructure assets. Others include patronage risks that impact passengers through an airport or cars passing through a toll road, as well as regulatory risks which can be applicable to assets where cash flows are predicated on a regulatory regime, such as utilities.
Climate change and transition risks also require deep consideration during this time and should be mitigated where possible at the time of acquisition and throughout the holding period of the investment.
“Large asset owners, such as for-member superannuation funds, have well-established governance frameworks to make these adjustments with Covid-19 continuing to be a living stress test of such processes,” Dr Drew said.
There is a lot of variance between the performance of infrastructure assets, with some even experiencing tail winds during Covid-19. Some ports have performed well due to significant discretionary spending on consumer goods instead of travel, and digital infrastructure has experienced higher demand as more people work remotely.
All of this underscores the importance of finding a representative index for benchmarking the performance of infrastructure assets, particularly Australian unlisted infrastructure, Dr Drew says, and on this topic there is currently heated debate.
“It is vital for the confidence of the sector that the final selection of an agreed benchmark represents the actual opportunity set available to investors, and clear consideration is given to matters including the depth of the index, the mix of core, core plus and opportunistic assets, survivorship bias, and the mix of hedged and unhedged returns, to name but a few,” Drew says.
Australian Super fund have led the way on how infrastructure assets are valued, Blanc-Brude stresses–a combination of funds tendency to hold a lot of illiquid assets not just in Australia but around the world, and also of Australia’s advanced and robust trustee system.
But 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.
Balancing the long-term nature of these illiquid investments with daily liquidity needs and members’ switching capabilities is difficult, and regulators’ attempts to grapple with this issue have been controversial.
Listed proxies are inadequate for unlisted infrastructure, Blanc-Brude says, because they are not representative at all. And private data reported by asset managers suffers from serious issues: It tends to be selective and so doesn’t wholly represent the market, and it usually has survivorship bias due to only successful funds reporting, leaning towards unrealistically high returns.
EDHECinfra collects bottom-up company and deal price data to measure 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. The unlisted infrastructure equity risk premia is estimated using advanced statistical methods, making unlisted infrastructure more directly comparable to other asset classes.
The TICCS infrastructure investment taxonomy also 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.
“Members of super funds deserve a fair benchmark,” Blanc-Brude says, and it is now possible to value these illiquid investments once a month while marking to market.”
In Q3 2021, EDHECinfra is launching infraMetrics, a data platform for investors in infrastructure covering cash flow data, valuation and risk metrics, market and fund strategy benchmarking and from early 2022, peer groups and asset rating tools.
This article was written in partnership with EDHECinfra.