Infrastructure risk put to test with COVID-19

The coronavirus crisis is forcing investors to rethink risk for an infrastructure asset class many had come to see as an alternative source of the steady yields once provided by government bonds.

Whether that review results in tweaks or more material adjustments will depend on how long the crisis lasts and how deep the economic downturn proves, market participants say.

Reviews for the March 31 quarter will find many asset owners reporting negative returns for their infrastructure holdings — a painful, if temporary, surprise, said Frederic Blanc-Brude, the director of Singapore-based infrastructure benchmark provider EDHECinfra and EDHEC Asia-Pacific.

The point of interest will be how investors' understanding of risk changes in the aftermath of the COVID-19 pandemic, and what they will do as a result in diversifying their infrastructure exposures, Mr. Blanc-Brude said.

"It's a good time for investors to question the assumptions they might have been making (to ensure) they're adapted to the new world that we now live in," said Raphael Arndt, chief investment officer of Australia's A$162.3 billion ($103.2 billion) Future Fund, Melbourne.

For example, in a world where unemployment in many countries could climb to 10% or 20%, it's worth considering "the capabilities of those populations to support essential utility bills under current regulatory arrangements," Mr. Arndt said in an April 27 update of the fund's latest results.

EDHECinfra's newest benchmark for global unlisted infrastructure companies, its infra300 equity index, registered a 6.37% decline for the quarter ended March 31 — well below the 11.6% drop calculated for the same quarter at the height of the global financial crisis in 2009.

While the latest quarterly drop reflects the considerable hit infrastructure assets have absorbed during the pandemic's containment phase, the inevitable impact of the global recession unfolding now has yet to be felt, Mr. Blanc-Brude said.

EDHEC's data show bigger infrastructure assets faring worse than smaller ones over the past quarter.

Index companies in the top quartile by size saw a median decline of 8.8%, more than twice the 3.5% drop for bottom-quartile companies, Abhishek Gupta, a Singapore-based investment solution specialist with EDHECinfra, said in an April 28 briefing on the latest quarterly index result.

That could prove relatively painful for large asset owners that have invested substantial sums in infrastructure and "now find themselves highly concentrated" in the big-ticket transportation assets most exposed to the COVID-19 lockdowns, said Mr. Blanc-Brude.

"The type of assets that very large asset owners purchase can be very different from ones that smaller funds such as ourselves might purchase," often using private equity-style fund vehicles, said Troy Rieck, chief investment officer of LGIAsuper, a Brisbane-based super fund with roughly A$13 billion in assets.

On April 21, LGIAsuper lowered infrastructure valuations by 3% for its balanced fund, which had a 9.6% exposure to infrastructure assets as of June 30.

That was less than the reductions three Melbourne-based funds announced almost a month earlier: The A$180 billion AustralianSuper fund cut valuations for its broader illiquid exposures by 7.5% while A$85 billion Unisuper and A$50 billion Hostplus lowered valuations for their infrastructure allocations by 6% and 7.5% to 10% respectively.

"The lack of diversification" in those institutional portfolios will make this episode all the more painful for big asset owners, Mr. Blanc-Brude said.

A greater focus on diversification going forward could put some wind in the sails of infrastructure fund-of-funds managers, after a long period where their added layer of fees has been a hard sell for asset owners, he said.

On April 27, Japan's Government Pension Investment Fund issued a request for information regarding emerging markets infrastructure funds-of-funds managers. The ¥169 trillion ($1.58 trillion) Tokyo-based pension giant said it was looking to further diversify its global core-focused infrastructure investment strategy — which is already dominated by infrastructure fund-of-funds managers.

However, a number of infrastructure managers pushed back on the contention that big asset owners aren't well diversified, noting that sizable direct investments in key airports and container terminals are often complemented by allocations to infrastructure funds providing exposure to scores of assets.

LGIAsuper's Mr. Rieck said investors focused on how well their infrastructure allocations are diversified could be losing sight of the bigger picture. Concentrated infrastructure exposures that provide strong diversification benefits for the broader portfolio could be a better outcome than highly diversified infrastructure holdings that result in a less diversified portfolio, he noted.

Meanwhile, Nick Kelly, a Sydney-based senior investment consultant with Willis Towers Watson PLC, said the fee sensitivity of many Australian asset owners should leave them relatively immune to the charms of fund-of-funds managers, especially those who took on the costs of building out internal teams to remove that first layer of fees.

The current pandemic has found many assets which proved resilient in previous downturns behaving differently in the face of government-enforced social distancing measures, said Padraig Brown, an Auckland-based principal with Mercer Investments' alternatives business and the consulting firm's head of real estate for the Pacific region.

"Once the dust settles, asset owners will again reassess the risks of the different assets in their portfolios," Mr. Brown said, adding "preparing for the previous crisis can lead to poor outcomes!"

The Future Fund's Mr. Arndt said his fund remains committed to being well diversified. "There are some concentrated risks in airports in particular at the moment, and toll roads and things like that," but for now it's important to see how that flows through to valuations, and the Future Fund will look to buy if opportunities emerge, he said.

Willis Towers Watson's Mr. Kelly said while views on what a well-diversified portfolio of infrastructure assets looks like are unlikely to change greatly, at least over the coming years the prices asset owners are willing to pay should come down from recent lofty levels.

"I don't expect asset owners to be overpaying," Mr. Kelly said, noting that the "very high multiples" of 25 to 30 times expected earnings they proved willing to shell out for ports and airports over the last five years could be closer to 15 or 20 times over the next 12 to 24 months.

Mr. Blanc-Brude said his polling of the more than 100 participants on EDHECinfra's April 28 briefing on its benchmark index's results for the first quarter showed less than 30% of respondents expecting the COVID-19 crisis to result in permanent changes for the infrastructure asset class. However more than 70% said the crisis has undermined asset owners' widespread use of absolute return benchmarks for judging the performance of their infrastructure assets.