Infrastructure has long been one of the more esoteric “alternative” investments, broadly defined as a separate asset class yet loosely grouped with both other kinds of non-market-correlated investments and one another.
Indeed, save for a few large and sophisticated pension plans, few have been able to differentiate among the numerous and varying kinds of infrastructure opportunities out there, instead lumping them all into one category (much in the same way many institutions lump hedge funds in “absolute returns”).
A recent report by The Pensions Institute entitled Infrastructure as an Asset Class (click here to download) offers a very deep and non-esoteric view of exactly what infrastructure investments are. Views include how the investments compare and contrast not only to stocks, bonds and alternatives but against each other and where the opportunities and pitfalls might lie for potential investors – if you will, a post-2008 and even post-2010 primer on infrastructure investments.
What the paper goes through in fine detail is concepts, market developments and empirical evidence on the risk/return and cash flow profile of infrastructure investments as well as the potential they offer for diversification and inflation protection in investor portfolios. The chart below shows the risk profiles of different kinds of infrastructure investments compared to other asset classes.
It also delves into broad perceptions of what an infrastructure investment actually is and challenges typical characteristics both good and bad that investors presume infrastructure brings to the table.
For instance, while many perceived value propositions of infrastructure investments are true, such as attractive returns and low sensitivity to economic and financial market swings, a lot of other elements aren’t usually considered. These unconsidered elements, for instance monopolies on a lot of infrastructure plays, make it tough to invest or divest. Other elements are political protection of certain sectors, which can either go up or come down at any time, and even some kinds of assets like transport, which can be much more cyclical than people might think. The net losses sustained on the Eurotunnel is an obvious, concrete example.
“Intuitively, such claims often make sense, and people can easily find individual examples that fit well into the picture,” the report noted. “However, it may be problematic to generalize too much and too quickly, as questions may be raised on each point.” The chart below shows how widely returns can fluctuate compared to more traditional asset classes.
There are also a lot of different ways to invest in infrastructure, each with their own risk-return profiles that don’t always fit the mold.
And there are a lot more risks than most people might not realize or even consider at first: everything from construction to leverage and interest rate to legal and ownership to regulatory to environmental. Even social risks can be factor – opposition from pressure groups and corruption, for instance.
None of that even begins to address the investment-side risk investors potentially face when plunking money down on a road or toll bridge or new network – proper diversification, transparency, timing, legal, regulatory/fiduciary and even just a general lack of knowledge and experience with a particular infrastructure play.
The paper further explores returns, specifically for vintage infrastructure buyout and real estate funds (click here for AllAboutAlpha.com’s synopsis of vintage infrastructure opportunities), noting that, again contrary to popular perception, returns don’t always go up in a nice straight 15%-a-year line. Same with infrastructure bonds and other kinds of vehicles that investors can put money into.
“As far as the risk-return profile is concerned, return targets of private infrastructure funds are still ambitiously in the double digits despite some recent moderation,” the author wrote.
Indeed, according to the report, the early experience with infrastructure funds is at best mixed in the boom-bust environment that has prevailed since the mid-2000s, even with dedicated infrastructure funds having mushroomed and investment volumes having surpassed the US$200 billion mark.
By the same token, the importance in overall asset allocation for most investors is still small; for example, while definitely growing, less than one-percent of pension funds’ assets are allocated globally.
Growth and debunking stereotypes that investors have when it comes to infrastructure investments is what the author focused on most here: there is “considerable” confusion among both practitioners and researchers in the field about everything from how infrastructure is defined to what are attractive investment characteristics and appropriate investment vehicles.
Bottom line: Infrastructure is here to stay, but the jury is still out on how to define it and how it can be implemented in a broader portfolio. To our recollection, the exact same thing was said of hedge funds 10 to 15 years ago.