If one examines the annual reports of many unlisted infrastructure equity funds a surprising pattern appears: given the level of returns reported, the risk implied by the volatility of the valuations is surprisingly low (table 1). For that level of volatility, over a 10-year period, yielding such high returns could even be perceived as dubious.
There is of course another explanation, which does not call into question the good faith of fund managers but should nevertheless be a source of concern for investors in infrastructure funds: the reported data is wrong.
In effect, using new mark-to-market data that reflects the evolution of the fair value of infrastructure equity investments (table 2), reveals that the volatility of appraisal NAVs is off by an order of magnitude, thus making infrastructure portfolios look like an unbelievably good deal.
Table 1: The Unbelievably Smooth Risk and Return Profile of Infrastructure Appraisals
Source: Annual reports, NAV of assets for 13 funds of unlisted infrastructure equity representing USD23.4bn of investment in 2020
Table 2: The Realistic Risk and Returns of the EDHECinfra Broadmarket Equity index
Source: EDHECinfra Broadmarket Index represent USD230bn in 2020, available at indices.edhecinfra.com
Fair value matters
Once the risks of infrastructure investment have been taken into account, recent academic research has shown that unlisted infrastructure equity and debt remain very attractive investments that always have their place in the long-term allocation of investors. Taking fair market valuations reflecting the price of risk into account is necessary to make any informed investment decision.
For instance, accurate market valuations are essential for secondary market investments, especially “continuation” funds, which allow managers to pass the investments made by previous funds to newly raised ones. As long as the assets are transferred to the new fund at their fair value, this kind of deal is completely fine.
Fair valuations are also the starting point of adequate yield management. For many investors, infrastructure investment is equivalent to holding bonds with an attractive yield until maturity. Entering at the right price point is therefore important, since cash yields do not only depend on cash flows but also on the acquisition price of these cash flows. You cannot know the current yield without knowing the latest market price.
Being a long-term, buy-and-hold investor does not change this reality: future cash flows may be paid over a long period but knowing their present market value is necessary to ensure prudent and compliant risk management. Even if the short-term volatility of infrastructure investments is not a concern for long-term investors, their prudential and fiduciary responsibilities require they conduct impairment tests and to know the liquidation value of their assets, as is the case for any financial assets held in connection with financial liabilities. Long-term investment should not mean blind investment.
Join the evolution
Investors in unlisted infrastructure can now do much better than relying on stale values. Since 2019, EDHECinfra has been measuring the fair value of hundreds of unlisted infrastructure companies each quarter by relying on high quality data and advanced asset pricing technology using machine learning to extract the latest price of risk from recent secondary market transactions.
Thanks to this innovation, market discount rates, risk premia and valuation metrics for numerous segments of the unlisted infrastructure market can be produced. Investors can use this data to assess the fair value of their existing assets, review new transactions prices, understand the risks and the true yield of infrastructure asset class. Crucially, they do need to wait for an exit to find out what the fair value of their infrastructure assets actually is. With credible fair market value estimates, EDHECinfra create indispensable information for investors to take sensible and prudent investment decisions.