- Private-infrastructure assets are often considered to act as inflation-hedged high-income bonds, whose risk and correlation can be modeled using the returns from smoothed, lagged valuations or investment-grade public bonds.
- This view implies very low betas and hurdle rates for inclusion in the total plan, which are key elements in the asset-allocation decision.
- Accounting for the heterogeneity of infrastructure assets, private risk premia and reporting bias may reveal higher volatility and correlations that may change allocators’ views on the role of infrastructure in the total plan.
Private infrastructure is a popular and growing element of institutional capital allocations. The USD 1 trillion U.S. infrastructure bill, in addition to increased public and private focus on renewable or carbon-neutral infrastructure, may mean significant new investment opportunities in private infrastructure in the coming decades.1 As a source of stable, indexed cash flows, infrastructure has been both an income asset and inflation hedge — qualities that are especially attractive in the current low-yield and high-inflation-risk environment. In addition, many infrastructure funds market themselves as sources of diversification. However, the performance of some private-infrastructure assets — especially transportation infrastructure — during the COVID-19 pandemic suggests that they are not immune to the economic growth shocks that drive public-asset returns.
Different Perspectives on Private Infrastructure
A common assumption is that private-infrastructure assets can be treated as nominal bonds. However, this view neglects the heterogeneity of private-infrastructure assets, which span a spectrum from equity-like to bond-like. Furthermore, this assumes there is no risk premium for private assets over their public counterparts. An alternative is to simply base decisions on private-infrastructure valuations, but these are not tradable market prices and tend to imply artificially low risk and correlation with public markets due to their smoothness. The MSCI Private Infrastructure Model, powered by Burgiss and MSCI Real Estate data, accounts for valuation smoothness and the heterogeneous nature of private infrastructure, combines information from public and private markets and incorporates the private risk premium.
The exhibit below examines key metrics for asset allocation for a hypothetical U.S. private-infrastructure portfolio2 using three different approaches: naïve estimates from smoothed-valuation time series, a simple bond proxy and the MSCI Private Infrastructure Model, with a listed-infrastructure index for reference. The MSCI model estimates higher volatility and correlation with equity than both the bond-proxy and smoothed-valuation views, but lower than listed infrastructure. Furthermore, the public-bond proxy overstates the correlation with U.S. Treasurys relative to other views. This may reflect the fact that not all private infrastructure is bond-like, or that the private-asset risk premium is not correlated with the public market.
Private Infrastructure’s Role in a Multi-Asset-Class Portfolio Varies Based on Modeling Approach
Volatility and correlation estimates are based on fund valuations, listed infrastructure equity, investment-grade-corporate-bond proxies or the MSCI Private Infrastructure Model. Infrastructure data comes from Burgiss and MSCI Real Estate; listed infrastructure comes from the MSCI USA Infrastructure Index; U.S. Treasury data comes from the IHS Markit iBoxx USD Treasuries Index; and the investment-grade proxy comes from the IHS Markit iBoxx USD Liquid Investment Grade Index.
What Does This Mean for Asset Allocation?
From the perspective of an asset allocator, these competing views can imply significantly different levels of return required from private infrastructure in a multi-asset-class (MAC) portfolio. Consider a hypothetical MAC portfolio that is 50% invested in equity, 40% in government bonds and 10% in private infrastructure. What is the beta of private infrastructure relative to such a portfolio?3
The exhibit below shows the beta of the infrastructure portfolio to the MAC portfolio using different approaches. The smoothed-valuation view says that private infrastructure has a low beta of around 0.1. In this view, a very low return would be required from the private-infrastructure portfolio to justify its inclusion in the broader portfolio. The public-bond proxy, like the smoothed-valuation view, says that private infrastructure has a low beta of around 0.2. The MSCI model comes in higher than either of these views, estimating the beta to be 0.6, although still significantly lower than listed infrastructure (1.3).
MSCI Model’s Private-Infrastructure Beta Differs from Other Common Measures
Private infrastructure has attracted significant inflows in the past decade. But the precise role it may play in the total plan — and, importantly, the return expectations that are required to justify an allocation to private infrastructure — depends critically on the risk and correlation of the asset class with the broader portfolio. More-sophisticated analysis that avoids the assumptions of valuation- and proxy-based estimates may offer a middle way.
1See for example: “FACT SHEET: President Biden Announces Support for the Bipartisan Infrastructure Framework.” www.whitehouse.gov, June 24, 2021.
2The hypothetical U.S. private-infrastructure portfolio is unleveraged, containing 55% of assets in U.S. utilities, 25% in U.S. industrials and 20% in North American energy, based on relative market caps. As infrastructure assets are heterogeneous, an infrastructure portfolio may differ from the one used in the analysis.
3In a mean-variance optimal portfolio, beta is equal to the expected return of an asset expressed as a fraction of the portfolio’s expected return.
MSCI Private Infrastructure Model Research Notes (client access only)