Shall I compare thee to a premium over inflation, a selection of peers, a public equity index, or another alternative asset class? None of these questions have the poetic quality of Shakespeare’s “Shall I compare thee to a summer’s day?” But then the greatest writer in the English language never had to wrestle with the challenge of identifying an appropriate benchmark for the infrastructure asset class.
Those who do face that challenge recognise the importance of getting to grips with the issue. I’m sure our readers are by now well acquainted with the so-called infrastructure financing gap and the need to attract long-term investors to help address it; and also with the obvious disparity between the professed enthusiasm of investors for infrastructure and their apparent unwillingness to commit capital to it.
One reason for this reticence is almost certainly the problem of benchmarking, a fundamental precursor for strategic asset allocation decisions – and particularly important when you’re contemplating, as with infrastructure, a long-term exposure that requires a view of expected performance over a lengthy time period and fluctuating economic conditions.
It would help if “infrastructure” were essentially homogenous. The reality is that it’s far from that, being instead a clumping together of extremely diverse assets with very different risk and return profiles. Thus, benchmarking with reference to a peer universe of infrastructure funds can be problematic unless said universe is carefully selected.
Many investors have sought to benchmark infrastructure in relation to a premium over the Consumer Price Index (CPI) of around 400 to 450 basis points. This seems appropriate for those investors for which one of the biggest reasons for investing in infrastructure – if not the biggest reason – is as a hedge against inflation. These investors will generally be targeting core infrastructure.
For those with an appetite for greater risk/return, various benchmarks have been used. Public or private equity have been referenced as direct comparators for infrastructure. Meanwhile, some sophisticated investors – especially those that have migrated increasingly to infrastructure as a bond substitute – have begun benchmarking around target cash yields.
One of the biggest infrastructure benchmarking exercises has been undertaken by the EDHEC-Risk Institute, which produced a recent paper entitled “Benchmarking long-term investment in infrastructure”. Interestingly, the EDHEC approach involves using project finance as its benchmarking “reference”. For reasons of brevity, we will not expand on the reasons for this here but, for those interested in the subject, a read-through of the paper on EDHEC’s website (www.edhec-risk.com) is thoroughly recommended.
For all the different approaches, perhaps the most important thing to note is that the importance of benchmarking the infrastructure asset class in a way that makes sense for investors (and, indeed, regulators) is now centre-stage. We understand that the EDHEC paper was discussed at a recent meeting of the G20’s Investment and Infrastructure Working Group, for example.
In all likelihood, it will come to be seen as an important contribution to increasing investor understanding of the asset class, as will the recent announcement that German research organisation CEPRES is partnering with that country’s Association for Alternative Investments (BAI) to launch an information platform with granular details of more than 2,000 infrastructure transactions.
This may be welcome news to the sovereign wealth fund representative who, we were recently informed by a market source, was considering parking “billions of dollars” of the fund’s available capital in infrastructure debt. He apparently had one pressing question at the front of his mind: “What is the benchmark?” The time may be getting closer when it’s possible to respond to that question with a convincing answer.