Author Details

Yang Liu

Yang Liu
Executive Director, MSCI Research

Sheng Yao

Sheng Yao
Associate, MSCI Research

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Private-Infrastructure Risk: Tilting at Windmills

  • Private-infrastructure investments span the risk and return spectrum from the equivalent of high-quality municipal bonds to risky early-stage ventures.
  • Investors may miss this heterogeneity and equate infrastructure risk to a BBB bond, with stable cash flow and low-volatility yield. Performance during COVID suggests cash-flow uncertainty may be an important consideration.
  • The MSCI Private Infrastructure Model can identify relevant systematic risk drivers. Using asset-specific information, investments are characterized by differentiated factor exposures, risk profiles and market correlations.

Private-infrastructure investments are often treated as comparable to relatively safe long-duration bonds with attractive yields, but this approach can mislead investors as they evaluate risk, yield and portfolio hedges. For example, at the onset of the COVID-19 crisis private-infrastructure funds in the energy sector experienced unprecedented losses: 8.1% in the first quarter of 2020. Funds invested in private-transportation infrastructure also revalued their assets substantially lower as the outlook of future asset cash flows became gloomy. As shown in the exhibit below, these sectors diverged substantially from U.S. government bonds, calling a bond-like treatment into question. Proxying these investments with low-risk bond positions would have greatly understated private infrastructure’s risk, and any expected hedging benefit would have been illusory.

 

US Transportation and Energy Private Infrastructure Have Been Dominated by Growth Uncertainty

Private-infrastructure index and listed-infrastructure index are deleveraged.

 

That’s not to say that all private-infrastructure assets are equity-like; some do have predictable, bond-like cash flows. But treating all private-infrastructure investments the same is oversimplifying. They have different fundamental risk drivers and sensitivities. For example, the value of an asset with stable cash flows, such as a regulated utility, is primarily driven by movements in interest rates and credit spreads. An asset with volatile cash flows that can covary with economic activity, such as a highway, is more exposed to growth and an equity-like risk premium. In the middle are hybrid assets such as airports, which have volatile revenues from air traffic and stable revenues from long-term leases.

Leveraging Burgiss and MSCI infrastructure data, the MSCI Infrastructure Model identifies the correct drivers of risk for infrastructure assets. It accounts for the asset characteristics that determine cash-flow-risk profiles and classifies assets as bond-like, equity-like or hybrid using a decision tree such as the one in the exhibit below. The model also considers that assets with the same risk drivers may have different exposures. A toll road with heavy truck traffic is more sensitive to economic growth than another one with mainly small-car traffic.

 

Using a Taxonomy Decision Tree to Classify Assets by Cash-Flow Characteristics

 

 

Tracking Infrastructure Risk Across 2020

With a firmer grasp of distinct risk drivers and exposures, it’s clear that different private-infrastructure assets may have weathered the COVID-19 crisis differently. In the exhibit below, we examine the risk evolution of several U.S. infrastructure assets over the course of the crisis. The asset examples include two wind farms with different credit qualities (bond-like, with contracted cash flows), a hybrid airport and two equity-like assets: a communication tower and an oil pipeline.

 

Infrastructure Assets’ Total Risk Took Different Paths Through COVID Crisis

 

The modeled assets covered a wide spectrum of risk, with an annualized risk forecast varying from 5% to 35%. All assets experienced a significant rise in risk at the outbreak of the crisis, with gaps driven by differences in asset type, quality and sector. Note that equity-like assets on average are riskier than bond-like assets. The risk of the investment-grade wind farm climbed up in March and April and has returned to its pre-crisis level, while the risk of the high-yield wind farm remained historically high because of heightened credit-spread volatility. Energy and transportation were hit the hardest during the COVID-19 pandemic, which caused a sharper spike in the risk of the oil pipeline and the airport than in the cell tower or wind farms.

As these examples demonstrate, analysis of private infrastructure within a broader portfolio may benefit from a comprehensive approach that considers important asset specifics, rather than a run based on some imaginary average investment.

 

Further Reading

Was Infrastructure Solid During COVID-19?

Regulation