QFIP 126 - Infrastructure as an Asset Class Flashcards
Definition of Infrastructure as an Asst Class
- Includes projects related to economic and social infrastructure, as well as companies that engage in such projects:
- Economic infrastructure projects (airports, roads, utilities, renewable energy)
- Social infrastructure projects (schools, healthcare facilities, stadiums, etc)
List investments characteristics of infrastructure
High barriers to entry
- *Economies of scale** (high fixed costs, low variable costs)
- *Inelastic demand** for services
- *Low operating costs**, high target operating margins
- *Long duration**
Disadvantage of investing in Infrastructure Funds
- have pretty high fees
- One study showed that the median management fee of infrastructure funds is estimated to be 1.75%
Comment on volatility of cash flows of infrastructure companies and their
correlation with cash flows of other investments
- Cash flows of infrastructure companies are less volatile than those of equities
- Cash flows of infrastructure are not correlated to those of equities
- Low correlation between infrastructure sub-sectors provide potential for diversification within infrastructure
Outstanding Issues and Developments for Investing in Infrastructure
-
Private-equity vehicles:
- investors feel “missold” since they are looking for a stable, long term investment, but the private equity funds they use to invest in infrastructure are highly leveraged.
-
Duration mismatch:
- Investors (i.e. pension funds) have long-term liabilities > lifetime of many infrastructure vehicles (typically 10 years) –> reinvestment risk
-
Fees:
- Large private equity-like fees
-
Governance:
- Low transparency and governance standards
-
Direct Investment:
- Stronger control at lower cost but increased exposure to high project-specific risk
-
Asset class diversification:
- Failure of asset class diversification in the financial crisis
List ways an investor can obtain exposure to infrastructure assets
The stocks of publicly traded utility, transport, or energy companies
- *Infrastructure bonds** (i.e. US municipal bonds)
- *ETFs** or derivatives built around listed infrastructure indices
- *Private equity**-type investments (mainly closed-end unlisted funds)
- *Listed** infrastructure funds (open or closed-ended)
- *Direct** investments in listed or unlisted infrastructure companies
Who are the most common investors of infrastructure funds?
Investors of infrastructure funds are typically large institutions with long duration
liabilities. They include:
- Public and private sector pension funds
- Endowments
- Insurance companies
Smaller institutions who have limited funds, need to protect liquidity, and have shorter duration liabilities should not invest in infrastructure
List a few benefits of investing in infrastructure
- Attractive returns
- Low sensitivity to market
- Diversification
- Long term, stable, and predictable cashflows
- Good inflation hedge
- Duration matching
- Low default rates
List some possible benchmarks for infrastructure funds
- Absolute rate of return
- Inflation, plus a margin
- LIBOR or bond yield, plus a margin
- Blend of equity, real-estate, bond, and private-equity
- Listed-infrastructure index
- Peer group of unlisted infrastructure funds
List risks of investing in infrastructure
Risks of investing in infrastructure at the level of infrastructure projects and companies include:
- Construction risk
- Operational and management risk
- Leverage and interest rate risk
- Refinancing risk
- Legal and ownership risk
- Business risk (demand and supply)
- Political and taxation risks
- Regulatory risks (fees, concessions)
- Environment risks
Additional risks at the level of infrastructure funds and vehicles include:
- Concentration/cluster risk (invested in too few assets in portfolio)
- Illiquidity risk (immature secondary market)
- Pricing risk (incorrect valuation basis)
- Risks related to governance of investment vehicles (ex: opacity)
Are listed infrastructure indices a good proxy for insfrastructure in the alternative
investment space?
Although they are a good point of reference, listed infrastructure is primarily driven by stock market volatility and is unlikely to be a good proxy for infrastructure in the alternative investment space.
- Listed infrastructure typically has high correlation with general stock market indices, negative skew, and high kurtosis
Comment on the diversification benefits of adding listed infrastructure funds to a
portfolio
The diversification benefits of listed infrastructure funds are not as good as one may think
- Studies of listed infrastructure indices show high correlations with general stock market indices (50 to 80 percent)
- Listed infrastructure funds have high volatility as well, which could be undesirable for a portfolio that is concerned about high volatility
Comment on the diversification benefits of adding unlisted infrastructure funds to a portfolio
So far, historical studies have shown that unlisted infrastructure funds provide more diversification benefit, because they have lower correlation with other main asset classes (equities, bonds, etc)
- However, note that these studies were only based on Australian data
- In addition, the data used for the Australian unlisted funds was of questionable quality
- During times of financial crisis, correlations with other asset classes tend to
- increase
- Diversification might be better considered across underlying economic drivers and market risk factors, rather than common financial-asset classes such as equities and bonds
- In addition, appraisal based valuation tends to underestimate volatility and correlations of unlisted instruments and overstate their diversification potential
Comment on how useful infrastrcture can serve as an inflation hedge
The inflation sensitivity of infrastructure returns is caused by contracted revenue
streams in projected or regulated tariff increases of utilities and toll roads
- Typically, the government would make sure that these tariff increases are indexed to inflation
The empirical research on the correlation between inflation and infrastructure has been mixed:
- Some studies find that the correlation between listed infrastructure indices and inflation is quite low
- However, other studies have shown that the cashflows of infrastructure companies grow faster than the CPI in the long run, offering some protection against inflation
- Thus, many infrastructure investors (insurance companies, pension funds,
- endowments) may decide to invest in infrastructure in order to hedge their
- inflation-linked liabilities
