How to judge when infrastucture is a good investment

EDHEC Business School recently launched EDHEC Infrastructure Institute (EDHECinfra), a research unit based in their Asia-Pacific headquarters in Singapore, with the ambitious goal of reducing the knowledge gap within the trillion-dollar infrastructure investment industry. 

EDHECinfra is created to help achieve a policy objective that has captured the imagination of the G20 – investing long-term savings into long-term capital projects. That requires channeling assets of institutional investors into non-traditional investments. 

Infrastructure investments should fit this purpose well: institutional investors look to increasingly use private, long-dated and illiquid assets to diversify and achieve their investment goals. Policy makers are also keen to support these infrastructure projects so that more jobs can be created to support growth. 

However, in the absence of reliable information on performance and risk, both investors and prudential regulators do not know how to treat infrastructure as an asset class. The issues include arriving at the right pricing for investors and concerns about systemic risks for regulators. This has prevented institutional capital from being deployed widely in this space, especially as certain prudential frameworks do not accommodate infrastructure investments at all. 

In the last year or so, the need to resolve these intertwining issues has moved up the ranks in the public policy agenda as the world faces a slowing global economy and volatile stock markets, creating an urgent need for institutional investors to seek alternatives to traditional investments for capital re-deployment or diversification. 

Unfortunately, the best available measures of risk adjusted performance of private infrastructure debt and equity so far, have been combinations of public equity indices – so-called “listed infrastructure” or indices created by averaging the internal rates of return (IRR) of a limited sample of private assets. Such indices are unable to capture the characteristics of private infrastructure projects and cannot properly measure risk. Listed infrastructure indices for example can be extremely concentrated in a few stocks and tend to be more volatile than the overall market. 

Similarly, there are few usable benchmarks on the private debt side. While rating agencies have documented default frequencies in certain classes of private project debt, these are insufficient to arrive at a comprehensive result that can build usable investment benchmarks.

EDHECinfra was created because of this lack of reliable measures for infrastructure investors. Backed by multi-million dollar sponsorships from by public and private institutions and by EDHEC Business School, EDHECinfra will bridge the information gap by creating benchmarks that can capture risk-adjusted performance, liability hedging characteristics, as well as extreme risk measures of infrastructure investments. 

The approach taken to sieve out usable data is a systematic five-step process. 

Firstly, infrastructure investments need to be well-defined as financial instruments. Secondly, the institute has developed asset pricing and risk models that take into account characteristics of infrastructure investments, such as the large “embedded options” present in private project finance debt. Researchers at EDHECinfra have been working on this technology since 2012 (prior to their spin-off in 2016 from EDHEC Risk Institute, Europe’s leading research institute for applied finance and investments). 

Thirdly, based on this technology, EDHECinfra has determined the data that needs to be collected and standardized. Hence a fourth stage during which EDHECinfra collects equity and debt cash flow data (we have been doing that at the asset level since 2015). 

By 2017, the EDHECinfra database is expected to cover in excess of 1,500 private infrastructure investments on both debt and equity sides, in the OECD and emerging markets, going back 15 to 20 years.  

Lastly, EDHECinfra designs portfolios of private infrastructure investments of equity and debt to be used as benchmarks for asset allocation, performance attribution and risk calibration in infrastructure investment. These benchmarks will then be published on an annual basis and will cover different types of infrastructure investments around the world.  

Grace Chen is Senior Relationship Manager at EDHEC Infrastructure Institute.