LONDON: An abundance of global savings. Trillions of dollars of negative-yielding bonds. And a bevy of institutional investors hungry for positive, long-dated yields to match their liabilities.
Conditions are ripe for an avalanche of private-sector capital to flow into unlisted infrastructure, turning an industry facing an estimated $49 trillion shortfall into an asset class which, its sponsors say, offers strong cash flows, uncorrelated returns and positive real yields.
58 per cent of active investors surveyed in the second quarter of the year by data provider Preqin will invest more than $100 million in unlisted funds over the next 12 months compared to 42 per cent who said that in the corresponding period last year, underscoring the increasing allure of alternative assets amid ultra-low yields from more conventional capital-market instruments.
But don’t believe the hype: unlisted infrastructure investments fail to deliver bang for the buck “- and the asset class remains handicapped by a dearth of investor-friendly investment vehicles.
That’s the conclusion of a research report from Deutsche Bank AG this week, which makes for grim reading for governments around the world.
“The supposedly attractive risk-return profile of infrastructure projects for private investors is illusory,” the Deutsche Bank analysts, led by John Tierney, wrote on Wednesday. “Simple as it sounds, bringing private capital to bear on the public infrastructure problem is an idea whose time has yet to come.”
A lack of well-designed or revenue-generating projects accounts for the funding gap, according to the McKinsey Global Institute. A less well-understood part of the problem is the risk-return profile of infrastructure investments for private investors “- which is also what’s keeping these investors away.
The Deutsche analysts argue that returns on such projects are usually meagre after taking into account mark-to-market and regulatory risks, the net effect of which crimps the allure of the asset class as a whole.
Specifically, they say the oft-touted low-volatility characteristics of unlisted infrastructure investments are overstated. “Studies of infrastructure returns are based on cash flows and appraised values since there are no markets for most infrastructure,” the analysts write.
“If more money flows in, regulators may require more rigorous appraisal methods, leading to more volatility, lower Sharpe ratios and higher correlations,” he said, citing the common measure for risk-adjusted returns.
In effect, efforts to encourage and systematise investment in the sector are themselves laden with risks.
“As more pension fund and life insurance money moves into public infrastructure, regulators could easily step in and mandate more robust appraisal methods, which could make current infrastructure returns less attractive on a risk-adjusted basis.”
Regulatory risks that might reduce the allure of a project’s economic value and inflation-hedging potential mean investors might not be adequately compensated for credit risk, they conclude.
The report is the latest in recent weeks from Deutsche Bank analysts pushing back against growing calls for governments in advanced economies to launch public works, citing, in part, the potential monetary offset.
The report this week serves as a shot across the bows for governments seeking to diversify their exposures into longer-dated assets, with the Norwegian sovereign wealth fund, the world’s biggest, expressing its wish this year to invest in unlisted infrastructure investments in the teeth of finance-ministry resistance, with officials citing the asset class’s lack of performance data and track record.
There is a case for the bulls: Preqin data shows the asset class has posted steady returns in recent years, while in Australia it outperformed during the 2007-2009 downturn.
But advocates that talk up unlisted infrastructure “- for diversification, and its potential in helping pension funds find long-dated assets to match ballooning liabilities “- concede there is a big problem.
Ashby Monk, executive director of the Global Projects Center at Stanford University and senior adviser to the University of California endowment, reckons the investment-conundrum lies more with market-structure challenges than the underlying risk-return profiles of projects.
Institutional investors are typically unhappy with the large fees incurred to middlemen, such as private-equity funds, he says. “It’s ultimately the high fees that prevent mainstream investors from deploying capital into this space,” he said in response to emailed questions. “Even 1 per cent per year over 20 years is devastating to the net-present-value of an investment. Also, the fee structures push investors into risky, levered deals to generate carry.”
Still, efforts to better align the economic value of unlisted infrastructure assets with the underlying investment product are gathering pace.
Pension funds are forming consortia to cut fees, while Monk is working on a new venture to help long-term investors gain access to well-curated projects.
But it’s an uphill battle “We think the current market structure makes it difficult for private investors to increase portfolio allocations into public infrastructure even to the modest level of one to five per cent of assets under management,” the Deutsche Bank strategists conclude.
