Getting the infrastructure in place

Transcription

1 Getting the infrastructure in place Ben Cooper, CFA Multi-Asset Analyst has existed as an asset class for more than 20 years and has grown on the back of some very compelling characteristics: inflation-linked income, quasi-monopolistic pricing power, long-lived tangible assets and a low sensitivity to the business cycle. Combined with target internal rates of return (IRRs) of 10% 12% per annum in an environment of low interest rates, this has attracted flows of over US$240 billion into unlisted infrastructure funds since We believe this paper is relevant for investors considering an allocation to infrastructure as well as those considering how to implement an already determined strategic allocation to the asset class. Sunil Kapadia Multi-Asset Strategist As a multi-asset analyst in Global Multi- Asset Strategies SM, Ben researches long-term asset allocation themes in order to assist clients with strategy and policy issues. His work also includes research on historical capital market performance and maintenance of various quantitative models and databases to support multi-asset research. As a member of Global Multi-Asset Strategies SM in Singapore, Sunil researches long-term asset allocation themes in order to assist clients with strategy and policy issues. Key points investment offers compelling characteristics inflation-linked income, long-lived tangible assets and target returns of 10% 12% that have led to institutional demand outstripping supply. Our analysis shows that the historical performance and volatility of the listed and unlisted infrastructure sectors are surprisingly similar. Combining listed with unlisted infrastructure investments offers complementary advantages, such as faster implementation, smoother income, exposures targeted to best suit investment objectives, and the ability to exploit valuation disparities. Demand has outstripped supply Despite the state of G7 government budgets and the creaky nature of developed market infrastructure suggesting a massive pipeline of projects in the decades to come, it appears that the demand from institutional investors has outstripped supply. Some commentators and analysts have pointed to an unlisted valuation premium 2, with investors struggling to increase exposure. The Organisation for Economic Co-operation and Development s (OECD s) latest survey of large pension funds reported that all respondents were below their target allocation, and that average unlisted infrastructure equity allocations had been more or less static since The reasons cited for the low levels of allocation include regulatory constraints, and a shortage of suitably structured assets and quality investments 3. Moreover, and in contrast to the global property market, most non-government-owned infrastructure is listed 4. This prompts the following question: Can and should investors seek complementary ways of gaining infrastructure exposure? 1 Preqin, Update (Q2 2016). 2 Willie Walsh, the CEO of International Airlines Group, reportedly called the 2 billion price tag for London City Airport a foolish price (FT, 2016). While it is just a single case, our own estimates suggest this deal was struck at a 100% premium to listed airports. 3 OECD (2015), Annual Survey of Large Pension Funds and Public Pension Reserve Funds. 4 According to Investor magazine (Wilde, June 2016), the total raised capital of unlisted infrastructure funds is US$375 billion. This compares to the listed market capitalisation of US$1 trillion US$1.7 trillion, depending on the index used.

2 2 versus unlisted performance and volatility There is no strict definition of infrastructure. We use as a working definition those assets that are considered essential to the functioning of an economy, which exhibit high barriers to entry and have limited exposure to the business cycle. This includes tolls, transmission networks, ports and prisons, and both existing assets (brownfield) and new projects (greenfield). Given that greenfield assets need to be built, investors should demand higher returns from them due to the associated construction and development risks, and the greater uncertainty around future revenue streams. In addition to asset and project type, investors can choose whether to access infrastructure via debt or equity. While we recognise the importance of the infrastructure debt asset class, we focus in this paper on infrastructure equity due to the availability of data. Until very recently, little data was available on the performance of infrastructure as an asset class. There now exist a small number of unlisted infrastructure benchmarks, from which we have chosen the widely available Preqin Index. This series starts in 2008 and covers over 200 unlisted funds with a combined market capitalisation of US$267 billion. As these funds are privately held rather than listed, the appraisal-based valuations generate smoothed performance with dampened volatility. To take account of this, we adjust the performance using a statistical process 5 that is commonly employed when assessing private markets. We then compare the raw and unsmoothed unlisted returns with four commonly used indexes that track publicly listed infrastructure companies. The performance and volatility of these six return series are shown in the table in Figure 1. Figure 1 Performance and volatility of returns Annualised total returns in US dollars (Mar 08 to Sep 15) Unlisted Unlisted Preqin Preqin (unsmoothed) DJ Brookfield Global MSCI World Core FTSE Developed Core S&P Global Arithmetic return Geometric return Standard deviation (volatility) 7.3% 7.2% 8.6% 13.9% 8.1% 6.9% 16.8% 5.3% 3.9% 17.2% 7.4% 6.7% 13.1% 3.8% 2.0% 19.2% Sources: Preqin, S&P Dow Jones, MSCI, FT 5 We employ the method outlined in Jorion (2012) that uses the autocorrelation coefficient to adjust the performance. We use a statistically significant, one-period lag.

3 3 The results show that the Preqin unlisted index and the DJ Brookfield and FTSE listed indexes 6 delivered similar performance. This is somewhat surprising as one might expect unlisted infrastructure to deliver a significant illiquidity premium 7 over the listed benchmarks. That said, our initial conclusion is that the jury is still out on whether unlisted infrastructure offers superior investment returns. This is consistent with the inconclusive findings of other studies. Peng & Newell (2007) found that Australian-listed infrastructure outperformed its unlisted counterpart by a large margin from 1995 to , while a more recently published study found that unlisted infrastructure outperformed by 0.65% p.a. 9 Less surprisingly, the unlisted market exhibits lower volatility (standard deviation of 8.6%, see Figure 1) than the listed benchmarks, which have a volatility range of 13% 19%. However, when measured over strategic horizons (5 10 years), the volatility of listed and unlisted assets tends to converge, and we believe that the unsmoothed Preqin data provides a truer gauge of the actual volatility in the unlisted sector. We take an unlisted market volatility of 14% in our capital market assumptions framework. Having seen that the differences in performance and volatility between unlisted and listed infrastructure are not as large as might have been expected, our next step is to better understand the composition of the indexes. Composition of listed and unlisted infrastructure markets The Preqin index is most directly comparable to the DJ Brookfield and FTSE indexes based on geographic exposure (see Figure 2). The underperformance of the MSCI and S&P indexes highlighted in Figure 1 can be attributed to their higher non-us-dollar exposure and different sector allocations. Figure 2 Geographical breakdown % Meanwhile, the MSCI and S&P indexes trail the others by a large margin and we will touch on compositional reasons for that in the next section. 7 This could be explained by any number of reasons, including a lack of seasoning in the underlying funds or high fees. 8 Peng & Newell (2007), The significance of infrastructure in investment portfolios, Pacific Rim Real Estate Society Conference. 9 Wilde & Wilde (2016), Unlisted fund returns: what do we really know? Investor magazine, September Preqin DJ Brookfield MSCI FTSE S&P North America Europe Rest of World As of June 2016 Sources: Preqin, FactSet

4 4 Sector exposures (Figure 3) are important because we would expect regulated assets and user-pay assets to have different growth and inflation sensitivities. While Preqin doesn t release sector breakdowns for its index, we can infer from deal flow that it has significant exposure to renewable energy, transport and utilities. This also more closely matches the DJ Brookfield and FTSE indexes. In contrast, the MSCI and S&P indexes have very large weights to telecoms (46%) and industrials (42%) respectively, which make them less comparable. Figure 3 Sector breakdown % DJ Brookfield MSCI FTSE S&P Utilities Industrials Consumer Disc. Health care Energy Financials Telecoms As of June 2016 Source: FactSet Is one better than the other? We don t believe that the listed infrastructure market provides a replacement for the unlisted sector, because the two markets are composed differently and offer different opportunities. This is especially applicable to large investors with the required long investment horizon and scale to undertake necessary due diligence.

5 5 However, our research suggests that listed infrastructure could be complementary to its unlisted cousin in several ways: 1) liquidity, 2) matching implementation to objectives and 3) valuation. We expand on these points in the following paragraphs and provide a summary in Figure Figure 4 Indicative infrastructure footprint Liquidity Valuations Market size Equity sensitivity Income Bond sensitivity Immediate distributions Inflation sensitivity Realised returns Greenfield exposure Realised volatility Brownfield exposure Unlisted assets companies As of September 2016 Source: Wellington Management Liquidity The greater liquidity of listed vehicles allows investors to gain infrastructure exposure quickly and easily as they patiently build their unlisted commitments. The latter can take some time to implement given the shortage of asset quality and structure we alluded to earlier, but also because of the importance of achieving vintage diversification (spreading fund investments across different years). A combination of unlisted and listed infrastructure in an immature allocation may also smooth income distribution as the unlisted component goes through the investment phase. In more mature portfolios, distributions from unlisted investments can be deposited in the listed component, where they will achieve some level of return from the asset class. This would simultaneously provide a practical solution to the reinvestment issue inherent in IRR calculations (which assume that interim receipts such as income or sale proceeds are reinvested at the IRR, although this isn t always possible), and a useful rebalancing function to the broader portfolio. 10 The web chart shows low/small readings close to the centre and high/large readings further from the centre.

6 6 Implementing objectives Implementation really matters in an asset class as heterogeneous as infrastructure. By altering the mix of listed and unlisted assets, investors can target their exposures to best suit their investment objectives. For example, an investor seeking inflation-linked returns with moderate risk should focus on brownfield assets in regulated sectors, such as transmission and water. This could readily be implemented by way of a core listed allocation and unlisted satellite holdings. In contrast, an investor seeking to maximise returns should focus on greenfield projects and opportunities in emerging economies, and should be willing to take on more exposure to the economic cycle. In that case, development and value-added projects (such as high-speed rail or expansions to meet passenger growth in emerging economies) in unlisted markets are likely to prove attractive. A mixture of listed and unlisted assets may also be a handy way to manage risk. Institutions should be conscious of home bias and the concentration in political and regulatory risk it brings. The addition of global listed or unlisted assets might help mitigate risk. Valuation Valuation disparities periodically exist between listed and unlisted markets, and this applies equally to infrastructure. Preqin estimates that unlisted infrastructure funds hold some US$142 billion of uninvested cash. This large amount of dry powder could help explain the unlisted valuation premium. The freedom to allocate across listed and unlisted infrastructure allows institutional investors to exploit any valuation differentials. Conclusion In summary, the similarity in historical performance and volatility between listed and unlisted infrastructure suggests there would be little performance drag from holding listed investments. In addition, our analysis suggests that the two markets are complementary with regard to their exposure type, while their differences in liquidity and valuation could offer opportunities to enhance returns.

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