Blended infrastructure – a portfolio for all seasons

October 2023 | SPOTLIGHT | FINANCE & INVESTMENT

Financier Worldwide Magazine

October 2023 Issue

This article sets out the case for building an infrastructure allocation using both private and listed infrastructure markets. We consider infrastructure a homogenous asset class and, as such, the optimal allocation between listed and unlisted infrastructure should be driven by individual investor circumstances. The single asset class premise is based on several long-term, high-level observations, including the views that the underlying assets owned by listed and unlisted infrastructure are the same, regulators of infrastructure businesses are the same, and management expertise is comparable between listed and unlisted, but it is also asset specific.

Characteristics of infrastructure vehicles

There are two distinct avenues for investing in infrastructure: (i) via listed companies; or (ii) through unlisted direct investments in the assets or via pooled vehicles.

Listed infrastructure offers a broad universe across sectors and geographies, while unlisted portfolios have typically lower asset diversity and geographic spread. Regulatory and stock exchange requirements mean listed companies are more transparent for investors. On the unlisted side, investors cite ‘control’ as a major benefit. Obviously, listed markets offer investors immediate liquidity, while unlisted transactions tend to take time. Both listed and unlisted infrastructure will offer investors predictable, stable cashflows as the underlying assets are the same.

Infrastructure sectors are not made equal

We find that the types of infrastructure assets owned by listed and unlisted investors vary between sectors, with some either under-owned or not owned at all by unlisted investors. In total, global assets represent over $6 trillion of assets.

Many large, regulated utilities, such as city gas or electricity distribution networks or long-distance pipeline infrastructure, are more difficult to invest in for an unlisted investor. This is not to say that investment is impossible, but evidence suggests that there is only a finite amount of capital that unlisted investors – whether individually or in a consortium – can and will commit to single infrastructure investments, and so ownership of these larger assets becomes more difficult.

Globally, some of the largest airports, energy distribution and transmission networks, pipeline networks, and water utilities are typically owned in listed markets.

Many industries offer similar-sized opportunities across either listed or unlisted investment routes, including airports and communications infrastructure assets. Electric utilities, particularly in North America, offer significant opportunities for listed investors. For instance, of the 45 investor-owned regulated electric utility parent companies in the US, 40 are listed. These companies alone have a combined market capitalisation of $980bn, and the top 15 each have a market cap greater than $25bn.

The sheer size of the equity value of these assets highlights why it is so difficult for unlisted infrastructure investors to penetrate the space. Similarly, we see North American pipelines as an under-penetrated sector in unlisted investor portfolios. The large cross-country pipelines and networks in Canada and the US are predominantly in listed markets.

Comparing the returns and volatility of listed and unlisted infrastructure is not straightforward. Listed infrastructure is valued daily and is therefore influenced by short-term market sentiment, resulting in short-term volatility. Unlisted infrastructure values, however, are based on periodic valuations of underlying assets, which typically occur on a quarterly basis.

Depending on the unlisted benchmark used, unlisted infrastructure volatility calculations are based on valuation estimates. These typically derive from a manager or independent auditor’s best estimate of the expected future cash flows to investors of an infrastructure asset, discounted to their present value.

However, these valuations are not equivalent to a market price, even on a quarterly basis. They lag the market, plus they are inherently smoothed. We would argue that relying on a smoothed basis for valuations, as proponents of unlisted infrastructure as a ‘standalone’ asset class do, is a flawed approach to measuring the true volatility of underlying assets or their cash flows.

We use the three main unlisted infrastructure benchmarks to compare performance versus the Global Listed Infrastructure Organisation (GLIO) Index. These are the EDHECinfra 300 Index which covers a market size of approximately $300bn, the Preqin Infrastructure Index which covers a market size of approximately $700bn, and the Cambridge Infrastructure Index which covers approximately $400bn.

In coverage terms, all three combined at $1.4 trillion are less than half the size of the $3 trillion market capitalisation of the GLIO Index. In enterprise value terms the GLIO Index is $4.8 tillion.

We have compared the quarterly performance of listed infrastructure using the GLIO Index to the most recently released unlisted quarterly data. We cover the period of Q4 2003 to Q4 2022, or a full 19 years of performance data.

We also calculate a private infrastructure mid-point index which is created using the mid-point of the high and low of EDHECinfra 300, Preqin and Cambridge over the 19 years observed. Interestingly, the high-low range of unlisted infrastructure benchmarks is wide over time. Unlisted infrastructure investors should be aware of this large variance when choosing their benchmark.

Ultimately, average annual returns for the listed GLIO Index and the Private Infrastructure Mid-Point Index are the same (10.9 percent per annum). Infrastructure outperforms global equities by 9.7 percent per annum, with approximately 250 bps lower volatility.

When focused on infrastructure volatility, to make results comparable, the unsmoothed private infra mid-point index volatility is 11.9 percent, up 2.2 percent from the smoothed 8.7 percent figure. The GLIO Index volatility is 13.5 percent. What is clear: the GLIO Index tracks the private infrastructure mid-point and vice versa over the analysis period.

With this insight, we can see how listed and unlisted infrastructure can be considered complementary. There is a strong argument for blending allocations between listed and unlisted, given that they indeed own the same types of assets. Using the enterprise value ($4.8 trillion) for listed infrastructure and pooling with the unlisted asset pool ($1.4 trillion) provides a combined investment pool of over $6 trillion.

We then use efficient frontiers to blend the GLIO Index with the private infra mid-point using optimal portfolio mixes based on the analysis above. The optimal infrastructure blend is GLIO Index 40 percent (listed) and private infra mid-point 60 percent (unlisted). The Sharpe ratio increases to 0.90 from 0.81 by adding the GLIO Index.

In a practical sense, there are diversification benefits of blending, partly due to the differences in valuation methodologies. For example, there have been periods where returns for listed and unlisted have been diametrically opposed due to the short-term lead or lag. If investors broaden their mandates to include all vehicles targeting ‘pure’ infrastructure, they can benefit from the full opportunity set of over $6 trillion of assets.

Conclusion – an asset class offering a large opportunity set

Blending listed and unlisted infrastructure offers a host of benefits, but many investors still view them separately. We would argue that to harness the full potential of an infrastructure allocation, investors need to adapt their thinking to access the full $6 trillion infrastructure opportunity set.

For a rational investor, listed infrastructure should be considered equally alongside unlisted in a holistic approach to infrastructure allocation. Inherent in this approach are several factors: fees, liquidity and portfolio rebalancing requirements, risk exposures, diversification, cash flows, opportunity sets, inflation protection, and perhaps most importantly, risk-adjusted valuations, as opposed to splitting the asset class by the method of accessing equity.

Based on the above, blending listed and unlisted infrastructure investments broadens the global opportunity set while reducing asset portfolio volatility and maintaining attractive levels of return.

Fraser Hughes is the founder and chief executive officer at GLIO and John Creswell is executive managing director at Duff & Phelps. Mr Hughes can be contacted on +32 (0)2 767 1888 or by email: f.hughes@glio.org. Mr Creswell can be contacted on +1 (312) 263 2610 or by email: john.creswell@dpimc.com.

Fraser Hughes

GLIO

John Creswell

Duff & Phelps