Parallel tracks(2)

Assessing infrastructure performance only makes sense when breaking the asset class down into discrete strategies.

Betting attracts two different types of personalities. First is the flamboyant gambler, who’s likely to seek outsize rewards by taking on a sizeable amount of risk. And then there is the conservative player, who’s ok with putting his money at risk as long as it’s on relatively safe bets. The former will typically engage in a game of relativity, happy to lose a few times as long as the winning bets bring big gains; the latter will carefully calculate his moves by relying on track record and history, poring over the form book to discover whether the horse he’s about to back is a consistent performer.

To the extent that alternative investing can be seen as a form of institutionalised betting, you could argue that the former would better describe the more aggressive forms of private equity while the latter would better depict infrastructure. As Jason Peasley, head of infrastructure at AustralianSuper, recently told us: “Expectations are that infrastructure represents a stable, long-term investment in an equity class that will generate equity returns but at a lower level of volatility than listed equities.”

Judging by the rising allocations to infrastructure around the globe, you would think institutional investors – typically conservative players in the alternative space – have seen in the asset class’s track record reasons to believe it is indeed an above-par, yet consistent performer. But one may wonder how they came to that conclusion. Not that it is necessarily wrong: a number of Canadian and Australian pension funds, which publish a breakdown of performance figures online, have done well out of their infrastructure programmes over the last few years. But it is very hard to find out whether Peasley’s assessment holds true for the asset class as a whole.

A couple of epistemological problems arise when trying to test the proposition. For one, our assessment can’t get past a form of knowledge asymmetry: while “horror stories” are given a lot of publicity, we only have a limited view on the performance of infrastructure investments that don’t become distressed or default. A second issue is that investors themselves don’t necessarily agree on what constitutes good performance. Depending on the sectors and strategies they target, return expectations can range anywhere from mid-single digits to close to 20 percent per annum.

There still are a couple of ways to evaluate whether the asset class has, so far, achieved its mandate. For a start, we can test the assumption that infrastructure is a resilient performer by looking at what happened in the aftermath of the Financial Crisis. On that point the jury is still undecided, but sounding rather positive. Certain GDP-linked assets did see their revenues plummet as growth slowed; other assets, even regulated ones, were also impacted as rates of returns came down as a result both of government pressure and the low interest rate environment. By and large, however, market observers agree that infrastructure has performed comparatively better than mainstream assets.

But to gain greater insight, we must look at longer time frames – and carve infrastructure into different sub-asset classes, each with its own dynamic and expected return target. Social infrastructure PPPs, for instance, have generally performed well, but risk-transfer mechanisms mean returns are low and currently being dragged down. The same broadly applies to renewable energy, which seems to offer good but diminishing returns as subsidy regimes fade out.

A third category comprises private equity-style strategies – less tied to a particular sector than the willingness to try and pocket capital gains by pushing assets to their next level of maturity. On that front views are mixed and very much tied to particular firms, with both notable failures and successes; the feeling is that the picture will be clearer in three to five years, when funds raised in the second half of the 2000s start lining up exits.

And then there is one other strategy: core infrastructure. “It’s the most dynamic sector,” a European fund manager recently told us. “It has largely performed in line with expectations.” It is in fact the strategy driving most interest from new investors, providing them with the archetypal high-yielding, lower-risk assets they’re looking for while allowing them to deploy sizeable amounts of money at once. But this popularity has a downside: most market observers reckon prices are being pushed up, especially for big-ticket assets.

Assessing the performance of the infrastructure asset class is thus only possible when breaking it down into more homogeneous groupings. And conducting this exercise leaves us with a worrying bottom line: in at least three of our four categories, returns appear likely to edge down. The various strands of infrastructure seem to have delivered satisfying returns so far – but in years to come, beating the odds will require investors to steer away from the beaten track.

Infrastructure Investor is currently carrying out its LP Perspectives survey, which tracks investors’ perceptions of upcoming opportunities and challenges for the asset class. We would love to hear your views – you can participate in the survey by following this link.