Listed and unlisted infrastructure – closing the gap

April 2022  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2022 Issue

A growing understanding of the differences between private and listed infrastructure may lead to a growth in listed allocations. The scarcity of quality assets in the private market, coupled with the growing amount of capital looking to invest – ‘dry powder’ and heady private asset valuations – will strengthen the case for listed infrastructure.

Over past years, most investors’ interest and ultimately allocations in the infrastructure asset class were focused on the private or unlisted side. However, there is growing interest among investors as to the alternative, or complementary, benefits of listed infrastructure. This is evidenced by the growth in assets under management (AUM) of dedicated listed infrastructure managers over recent years. Since 2016 AUM more than doubled to $145bn by the end of 2021.

The underlying enterprise value of our ‘Global Infrastructure Index’ constituents currently stands at approximately $4 trillion, and is roughly five times larger than the respective total enterprise value of the comparable benchmark for the unlisted side: Preqin Private Infrastructure.

Despite the obvious difference in investment wrapper – listed and non-listed – the underlying assets offer a long list of common features. The asset class ‘infrastructure’ is typically long-lived assets with contractual-based cash flows linked to inflation that aim to provide both income and capital appreciation over time. The assets require the same management experience to operate and manage them, and they have local market demand drivers and are subject to the same regulations. The investment, or return, performance is driven by underlying infrastructure projects and their respective cash flows and earnings. Finally, as essential components of the global economy, infrastructure exhibits large exposures to both the energy, utilities and transportation sectors.

With a focus on investing in listed infrastructure, the asset class enhances overall portfolio construction for investors in three key areas: (i) asset diversification; (ii) attractive valuations versus unlisted and tradability; or (iii) liquidity which cannot be offered by private asset stakes or unlisted investments.

Valuation differences

Historically, investors have consistently valued private infrastructure at higher enterprise value and earnings before interest, taxes, depreciation and amortisation (EBITDA) multiples compared to listed infrastructure. Historical averages are in the 30 to 40 percent premium range over listed multiples. This is mainly driven by the belief that private investments provide lower volatility and correlations compared to other asset classes. However, these perceived advantages may be overstated due to the smoothing effects of appraisal-based valuation methodologies used to value private infrastructure markets.

Appraisal-based index returns present a smoothed and lagged picture of what was happening at each point in time in the underlying private infrastructure market. This is caused by two phenomena: (i) the appraisal process at the level of individual infrastructure project valuation is essentially ‘backward looking’, as it relies only on past financials of projects; and (ii) the index construction process requires temporal aggregation of appraised values, as the index is constructed each period by averaging across the most recent appraised values of all the individual infrastructure projects (even those that were not reappraised during the current quarter).

This data problem causes the returns of appraisal-based indices to appear to have less volatility than is really the case, and to have less correlation with other return series that are not similarly smoothed and lagged. This distorts any direct comparison of the risk-adjusted investment performance of private and listed infrastructure (or of private infrastructure and liquid securities such as stocks and bonds) and biases the results of any mixed-asset portfolio optimisation analysis based on the index returns data.

In our research, we both unlagged and de-smoothed the private infrastructure series to provide a like for like comparison. In fact, in simple terms, the historical returns of listed and unlisted infrastructure have been remarkably similar over the past 15 years, each achieving annualised returns of approximately 11 percent. One could argue that listed infrastructure can be a bellwether for what is to come in the private space, due to the inherent lag caused by using an appraisal-based index.

Liquidity

The amount of dry powder (capital committed by investors that has not been invested) has climbed to record levels over the past decade in private infrastructure.

Much of this rise is a result of private infrastructure managers taking a cautious approach to deploying capital in the face of high valuations and limited or scarce private infrastructure opportunities. Additionally, levels of dry powder may continue to climb in the short term, if these market conditions persist and investors continue to allocate capital into this space to benefit from the COVID-19 recovery.

Private asset markets tend to exhibit a relative lack of liquidity and informational efficiency in asset pricing. With this dynamic in mind, another possible explanation for the comparable return performance between private and listed infrastructure is the greater liquidity and informational efficiency of the public capital markets; it exerts greater performance pressure on managers of public infrastructure companies, which weeds out poor performers.

However, on a long-term horizon, it is probably more logical to expect a higher return for equivalent assets that are held privately due to their lack of liquidity and a greater management burden for investors. Over the subject period mentioned earlier, this was not the case, as listed infrastructure performed in line with private infrastructure.

The more commonly discussed upside of liquidity in listed infrastructure is its ability to allow investors greater ease in portfolio rebalancing. Adding and trimming various infrastructure exposures on the fly is difficult and expensive, given higher valuation multiples, when dealing in private markets.

Attempting to time the market is also relatively more challenging on the private side, as the process for private infrastructure firms of raising and deploying capital can take considerable time. In fact, as of September 2021, there was over $300bn in dry powder held within private infrastructure funds. In listed infrastructure, by contrast, capital can be deployed instantly to provide exposure to companies already generating cash flows.

Mixing or ‘blending’ infrastructure

Blending private and public infrastructure may lead to more optimal risk and return characteristics for a portfolio. If an existing portfolio only contains private infrastructure, investors may benefit from adding listed to gain the return-enhancing characteristics of the variance of returns, diversification, in addition to the increased liquidity listed provides. On the other hand, a portfolio containing only listed infrastructure may benefit from adding private. Here, adding private infrastructure exposure to an existing listed portfolio may potentially soften volatility and allow access to differentiated infrastructure projects that may enhance returns.

In the end, asset owners will likely benefit from a blend of both private and listed infrastructure to achieve their desired optimal risk and return characteristics for their portfolio.

In conclusion, while private infrastructure is noted for its diversification benefits, predictable cash flows and low volatility, listed infrastructure can enhance diversification while still providing comparable contractual-based cash flows and annualised returns.

Volatility of listed infrastructure will always be relatively higher, in part due to the valuation differences of the private market. But over the long term, investors have not sacrificed performance when choosing to invest in listed infrastructure over private – returns come out at approximately 11 percent annualised.

A growing understanding of the differences between private and listed infrastructure may lead to a growth in listed infrastructure allocations in the future. The scarcity of quality assets in the private market, coupled with the growing amount of dry powder looking for a home and heady private asset valuations, will strengthen the case for many investors to seriously consider listed infrastructure.

 

Fraser Hughes is founder and chief executive of GLIO. He can be contacted on +32 (0)2 767 1888 or by email: f.hughes@glio.org.

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BY

Fraser Hughes

GLIO

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