Infrastructure Equity.

Infrastructure investments are a unique category within the realm of private market assets. They are characterized by their provision of services that have a relatively inelastic demand, meaning they are less susceptible to market cyclicality or economic shocks. For instance, utilities like water and electricity are essential services that people need regardless of the economic climate. These investments typically involve a high distribution of stable cash flows over long-term contractual periods. They may also benefit from significant barriers to entry, such as regulatory restrictions or high capital requirements, which limit competition.

Core Infrastructure Equity

Core infrastructure equity assets are the safest among infrastructure equity assets. They offer the lowest risk and return. However, their stable cash flows and favorable duration characteristics make them a long-term liability-matching alternative to default-risk-free government bonds. For example, a toll road operator would have predictable and stable cash flows from toll collections, making it a suitable investment for a pension fund that needs to match its long-term liabilities. These investments typically offer return levels well in excess of other long-duration investments, provided an investor is able to accept these assets’ lack of liquidity.

Insight into Infrastructure Equity Index

The infra300 equity index, which tracks unlisted infrastructure investments, had a return over a 10-year period (from 2009 to 2019) of just over 12% per annum, with a 13.9% total return volatility and just a 24% correlation with the MSCI World Index. This low correlation indicates that infrastructure investments can provide diversification benefits in a global equity portfolio.

Types of Investors in Infrastructure

The liability-matching feature of infrastructure investments is increasingly used by long-term institutional investors, such as pensions, sovereign wealth funds, ultra-high-net-worth individuals, and family offices. For instance, a pension fund with long-term liabilities might invest in a power plant with a 30-year power purchase agreement, aligning the investment’s cash flows with the fund’s liabilities. These investors align their allocation to such investments with their risk tolerance, return objectives, and market expectations.

Unlisted Infrastructure Investments

Despite their complexity and illiquidity, unlisted infrastructure investments can add diversified, stable cash flows to effectively match an investor’s anticipated liability cash flows in the context of an investment strategy and policy. For example, a private equity fund might invest in a portfolio of solar power plants, providing stable cash flows from the sale of electricity over the life of the plants.

Evaluation of Investments

The structure, method, investment process over the life cycle, and estimated market value of these assets are evaluated to thoroughly understand the expected risk and return of these investments. For instance, an investor might evaluate a toll road investment by analyzing the concession agreement, traffic forecasts, toll rates, operating costs, and financing structure to estimate the investment’s net present value and internal rate of return.

Practice Questions

Question 1: Core infrastructure equity assets are known for their low risk and return among infrastructure equity assets. Despite their lack of liquidity, they offer return levels well in excess of other long-duration investments. What makes these assets an attractive investment option for certain investors?

1. Their high risk and high return characteristics
2. Their stable cash flows and favorable duration characteristics, making them a long-term liability-matching alternative to default-risk-free government bonds
3. Their high liquidity and short-term return potential

Answer: Choice B is correct.

Core infrastructure equity assets are attractive to certain investors due to their stable cash flows and favorable duration characteristics, making them a long-term liability-matching alternative to default-risk-free government bonds. These assets typically include utilities, transportation, and communication infrastructure that provide essential services, and therefore, have stable and predictable cash flows. This stability is often due to regulatory protections or long-term contracts. The long duration of these assets matches well with the long-term liabilities of certain investors, such as pension funds and insurance companies. This makes them an attractive alternative to government bonds, which also have low risk and long duration, but may offer lower returns. The stable cash flows and long duration of core infrastructure equity assets can provide a steady source of income and capital preservation for investors, making them a valuable component of a diversified investment portfolio.

Choice A is incorrect. Core infrastructure equity assets are known for their low risk, not high risk. While they can offer returns well in excess of other long-duration investments, they do not typically exhibit high return characteristics associated with high-risk investments.

Choice C is incorrect. Core infrastructure equity assets are not known for their high liquidity. In fact, they are often illiquid due to the large capital requirements and long-term nature of infrastructure projects. Additionally, while they can provide steady returns over the long term, they do not typically offer high short-term return potential.

Question 2: Infrastructure investments are known for their unique characteristics among private market assets. Which type of investors are most likely to align their allocation to such investments with their risk tolerance, return objectives, and market expectations?

1. Short-term individual investors
2. Day traders
3. Long-term institutional investors such as pensions, sovereign wealth funds, ultra-high-net-worth individuals, and family offices

Answer: Choice C is correct.

Long-term institutional investors such as pensions, sovereign wealth funds, ultra-high-net-worth individuals, and family offices are most likely to align their allocation to infrastructure investments with their risk tolerance, return objectives, and market expectations. These types of investors have long-term investment horizons and large amounts of capital to invest, which aligns well with the characteristics of infrastructure investments. Infrastructure projects often require significant upfront capital and have long payback periods, but they can provide stable, predictable cash flows over the long term. This makes them an attractive investment for long-term institutional investors who are looking for steady returns and a hedge against inflation. Additionally, these investors often have the expertise and resources to manage the complexities and risks associated with infrastructure investments, such as regulatory risk, construction risk, and operational risk.

Choice A is incorrect. Short-term individual investors are typically not well-suited to infrastructure investments. These investments require a long-term commitment and can be illiquid, meaning they cannot be easily sold or converted into cash. This does not align well with the needs of short-term investors who may need to access their capital quickly.

Choice B is incorrect. Day traders are also not likely to invest in infrastructure. Day trading involves buying and selling securities within a single trading day, which is not compatible with the long-term nature of infrastructure investments. Furthermore, day traders typically focus on liquid, publicly traded securities, whereas infrastructure investments are often privately held and illiquid.

Glossary

• Infrastructure investments: Investments in physical systems and structures that provide essential services, such as transportation, utilities, and telecommunications.
• Core infrastructure equity: Equity investments in infrastructure assets that provide stable, predictable cash flows.
• Infra300 equity index: An index that tracks the performance of unlisted infrastructure investments.
• Unlisted infrastructure investments: Infrastructure investments that are not listed on a public exchange.
• Liability-matching: An investment strategy that aims to match the timing and amount of cash inflows from investments with the timing and amount of cash outflows for liabilities.

Private Markets Pathway Volume 2: Learning Module 7: Infrastructure; LOS 7(e): Discuss the risk and return among infrastructure investments and as compared to other investments as part of a strategic asset allocation