Diversification benefits are demonstrated in the returns of two large investors with complex portfolios: the Government Pension Investment Fund (GPIF) of Japan, and the Abu Dhabi Investment Authority (ADIA).

Both have large portfolios but they differ in their history of investing. GPIF is only at the beginning of its journey towards diversifying its holdings, while ADIA has a long history of investing in private equity, real estate, infrastructure, alternatives and equities, across both the capitalisation spectrum and various geographies.

GPIF returned 5.86 per cent for its fiscal year 2016, and has generated an annual rate of return of 2.89 per cent since inception. The fund, which now has funds under management of ¥144.9 trillion ($1.3 trillion), attributed its annual return to the positive impact of domestic and international equities.

For the year to the end of March 2017 (GPIF’s latest fiscal year) its domestic equities portfolio returned 14.89 per cent, foreign equities returned 14.2 per cent, and domestic bonds returned -0.85 per cent.

Historically, the fund has had a simple, conservative asset allocation, including a large holding in bonds, particularly domestic bonds. It is only now starting to diversify into equities, and holds no private or alternative assets. Over the last two years, it has decreased its allocation to domestic bonds by 10 per cent, re-allocating to domestic and international equities, which together now make up nearly half of the portfolio.

GPIF has made the unique statement that its investment horizon is 100 years; however, it allows its external managers to determine the holding period of their investments.

Meanwhile, the Abu Dhabi Investment Authority has a much more diversified portfolio. It has generated a return of 6.9 per cent a year over the 30 years to the end of December 2016. The 30-year return was 7.5 per cent at the end of 2015.

ADIA’s long-term policy portfolio asset allocation is developed equities (32-42 per cent), emerging market equities (10-20 per cent), small-cap equities (1-5 per cent), government bonds (10-20 per cent), credit (5-10 per cent), alternatives including hedge funds and managed futures (5-10 per cent), real estate (5-10 per cent), private equity (2-8 per cent), infrastructure (1-5 per cent) and cash (0-10 per cent).

In 2016, ADIA got positive results from its decision to expand its investment universe within the alternatives portfolio, allowing co-investments alongside managers in special situations, along with investments in smaller, capacity-constrained managers.

It also launched an emerging opportunities mandate to invest in asset types that fall outside the remit of ADIA’s other investment departments. It is expected to execute its first such investment this year, with a view to adding differentiated return streams and diversification to the total portfolio.

GPIF’s assets are all managed by external managers, whereas about 60 per cent of ADIA’s assets are managed externally.

Strategy at Denmark’s $15 billion insurer SEB Pension is focused on building a robust alternatives portfolio within a risk-proofing investment approach, the fund’s chief investment officer, Jørn Styczen, explains.

SEB, a defined-contribution (DC) multi-employer pension provider, offers guaranteed and non-guaranteed DC pensions. Assets under management have increased on the back of growth in Danish demand for non-guaranteed products.

A quarter of SEB’s assets are invested in an alternatives portfolio established in 2000, which has since grown to become one of the biggest allocations to alternatives amongst its European peers. It is here, Styczen explains, where he is prepared to spend parts of his risk and cost budgets, using active external management in allocations to distressed debt, senior secured loans, hybrid mezzanine funds, infrastructure and private equity.

Recent strategies include investing in senior secured loans through 2015 and 2016 while being short high yield, in a bid to protect the fund from geopolitical risk.

“2016 was not the best year to be short high yield and long loans, but loans have protected the fund against geopolitical risk and as the yield spreads currently are nil, loans are very attractive,” he says.

Along with loans, infrastructure is also a big allocation within the alternatives portfolio. Here, Styczen prefers value-added opportunities, rather than infrastructure that “just gives income”, like a toll road. He also favours strategies and managers that go one step further than simply “buying the asset”. An example is SEB’s investment with Copenhagen Infrastructure Partners in a new biomass-fired combined heat and power plant in the UK. The plant is set to generate enough energy for 50,000 homes when complete in 2018.

Copenhagen Infrastructure Partners typically taps the mezzanine part of the market; however, Styczen also invests with Global Infrastructure Partners and EQT, where assets are structured more like private equity. SEB received a 30 per cent return from its infrastructure allocation in 2016, due to mature funds “selling assets”. Infrastructure investments have already returned 4.3 per cent in 2017.

Side-cars address fees

The large alternatives allocation makes tackling high fees an ongoing priority. One way to achieve this is through co-investment with SEB’s prime managers, setting up side-car arrangements.

“Our managers increasingly set up a side-car vehicle, whereby we invest, say, $50 million [through] the fund, and $30 million [through] the side-car. It allows us to reduce our fees by 25-30 per cent.”

He adds that because SEB’s total portfolio is already well diversified by asset classes and managers, any loss of diversification from this strategy “is not a problem”.

Styczen says the alternatives portfolio is a stalwart in the face of today’s geopolitical uncertainty and high debt levels, and plans to build the allocation further.

“We have the expertise to commit more to alternatives,” he says. Recalling the global financial crisis, he notes the alternatives allocation withstood the crisis because SEB didn’t have to sell any assets and “all the values came back”.

Along with the 25 per cent allocation to alternatives, SEB has a 25 per cent allocation to listed equities, a 10 per cent allocation to real estate and a 40 per cent allocation to liquid credit, Danish mortgages and government bonds.

Liability management stays in house

Across the fixed income portfolio, SEB has developed a liability matching overlay. This enables managers of SEB’s only active external fixed income mandate to focus on the benchmark.

“When we outsource the fixed income portfolio, we don’t outsource the liability management,” Styczen explains. “We watch it all the time ourselves and adjust our hedge to make sure the duration is in line with our liabilities and expectations. It is much easier for the asset managers if you don’t give them liability targets, you just give them the benchmark.

“Large fixed income allocations are challenging because the returns are so low. This way we can do the duration matching as an overlay.”

The bulk of the equity allocation is indexed, with a derivative overlay, in a low-cost strategy that has allowed the fund largely to eschew active equity management and hedge funds. The exceptions are one active mandate to Danish equities, which accounts for 10 per cent of the equity allocation, plus two active, niche equity strategies.

Styczen has also developed a risk premia program to work alongside the equity allocation.

“Most smart beta or risk premia strategies are correlated to equity; if equity markets fall, you can lose money in a smart beta portfolio, and the strategies are difficult to view as separate asset classes,” he says.

SEB’s solution is to use part of the risk premia program alongside the equity portfolio and replace some equity exposure with short volatility strategies.

“We need something that works better with the equity,” he concludes.

A recent innovation included developing a tail risk-hedging portfolio in response to the geopolitical uncertainty of Brexit and the new Trump administration.

“It was successful but it proved very expensive when there wasn’t any volatility,” he says. “A tail risk hedge doesn’t work if nothing happens.”

Still keen to protect against geopolitical risk, but loath to reduce the equity allocation, and with risk “uncompetitive”, Styczen has now decided to restructure the risk-factor portfolio and add a defensive tilt to make it work alongside the tail-risk portfolio. To this end, SEB is developing a number of defensive strategies that would give a large gain should equity markets fall.

Donald Pierce, chief investment officer of the $9 billion San Bernardino County Employees’ Retirement Association (SBCERA), brings vision and a steady hand to investment strategy.

The portfolio he shapes is built around low equity exposure and diversification, with assets chosen according to their value, along with their contractual and income qualities. All SBCERA investments are viewed through these three lenses, in a blueprint that runs throughout the portfolio. This explains the chunky allocation to alternatives, the preference for debt instruments and the fund being “grouchy” about equity without dividends attached, Pierce says.

Value means buying assets at a significant discount to what they’re worth. A principle recently challenged in the California-based fund’s emerging-market debt portfolio by the sell-off in Brazil, which has tested the mettle of most credit investors.

“Brazil sold off, we bought in and it got worse,” says Pierce, a United States Air Force veteran who saw active service in the Gulf War fresh out of high school. “When you are interested in an area that has been beaten down, it doesn’t mean as soon as you enter it won’t get beaten down more. And the one time you avoid the first round, you can guarantee it will rally on you and you’ll get mad at yourself.”

The portfolio’s contract and income principles mean SBCERA favours assets containing contracts that at some point in time settle up or pay money back to investors.

“Benjamin Graham’s The Intelligent Investor talks about buying assets below intrinsic value, yet one of the things rarely talked about – which we take to heart – is that the market may never take you out of your position,” Pierce says, in reference to Graham’s 1949 book, which is a bible for value investors.

It means he hunts for assets that extract value through cash flows and don’t ultimately rely on market movements for a return. There is always a danger that the market won’t move. In that case, embedded contracts ensure payment of some kind, at some point, “if push comes to shove”.

These principles sit easily within alternative assets, where the fund has allocations to timber, infrastructure and private equity. Rather than focus on the individual assets, Pierce looks at their components.

“Is it equity or is it debt? Does it have leverage? When does the debt facility mature? Is there a significant amount of asset coverage? Each asset we have we would like to underwrite in some way,” he explains. “It is much more of an underwriting story than an alternative story. The income is the least volatile of those components. The price change is where the action is, but it is also where all the volatility is.”

Pierce, who succeeded his mentor, Tim Barrett, in 2010, has introduced new allocations to international private equity and emerging-market debt, as well as option strategies and a wide-ranging rebalancing program. Here, the portfolio’s allocation is adjusted every month, according to asset prices, within a fixed range.

“It doesn’t change that much; we are a low-turnover portfolio. However, the main criticism I have of any strategic asset allocation [when] folks don’t change it, is that they are saying the price of the asset they are purchasing doesn’t matter. If your asset allocation doesn’t change when the stock price and value have increased by 200 per cent ov

er the last seven or eight years, you are saying the price at which you buy assets isn’t [relevant] to your asset allocation and this doesn’t make sense.”

Cash pile

Accessing assets that combine value, income and contractual elements is a challenge in today’s climate. Couple that with some large sums coming back to the fund from maturing private-equity investments, and it means SBCERA sits on a cash pile amounting to almost 10 per cent of its assets.

“It definitely feels like a weight,” Pierce says. “We are finding it harder to deploy capital in a way that meets our cost of capital and this is reflective of the opportunities out in the marketplace. Spreads are tight, equity is rich, and while there are some isolated areas that are interesting, they are not areas you can lean into meaningfully. And, of course, as the market continues to rally, holding cash doesn’t look like a good idea.”

The cash pile has roughly doubled from its June 2016 proportion of 4.8 per cent. At that time, SBCERA had a quarter of its assets in the alternatives portfolio, with equity (33.6 per cent) fixed income and credit strategies (29.1 per cent) and real estate (6.7 per cent) forming the other allocations.

Managers and fees

SBCERA uses 50-60 managers, but “actively engages” with about 15 of them. The strongest relationships within this group are with managers that “truly understand” SBCERA’s investment philosophy. It is this select cohort that plays a key role in bringing new ideas to the fund.

“Our best managers come to us only with assets we like and have taken our investment approach to heart,” Pierce says. “That said, we do use managers that cause us to stretch away from these principles, test our predilections and bring real diversification. This is particularly related to growth equity, which doesn’t tend to fall into our philosophy of value, income or contractual.”

He likes managers that welcome investor input and are prepared to let him upsize various ideas and “add-on positions”.

“When managers that don’t always ask us for money do ask, it usually makes sense” he says. “When someone is always asking for money, then that is not the partnership we are looking for.”

He also runs a highly collaborative “standing table call-in” process where co-investment decisions involving managers include all investment staff on the call.

“All the co-investment decisions that come through involve the entire team, hands on deck.”

Investment management and performance fees in the alternatives portfolio came in at $47 million in 2016, out of a total investment managers’ bill for the year of $62 million.

Reducing fees is hard in buoyant markets, but Pierce cites examples of successfully securing better fees by working with managers on specific asset structures, such as risk-retention vehicles. He also argues that opportunities to invest with SBCERA are rare.

“It is hard to get into our portfolio, so when it opens up, it is important they agree to our terms.”

Strategy also includes the freedom to invest without constantly referring back to the board.

“We ask for a lot of permissions up front,” he says, although he is quick to nod to the board’s expertise.

“Have I ever had a brushback pitch?” he says, referring to when the board ditches an idea. “There isn’t a CIO out there who hasn’t had one of their ideas shown the exit. In some ways, this is better than if it gets in the portfolio, particularly if you [would have spent a lot of political capital defending something that] doesn’t work. At this point, either you kill it or the board will kill it. It’s a humbling business.”

Ten years after the global financial crisis, global growth is sluggish, inflation is hovering near record lows, and unprecedented experiments in global monetary stimulus have created the risk of asset bubbles. Put simply, current debt levels are unsustainably high and can’t be propped up forever.

That is the bleak assessment by Satyajit Das. He warns that with debt in many countries having reached three to four times gross domestic product (GDP), levels typically unseen since the Second World War, the ability of some sovereign issuers to keep paying back their debts is uncertain.

Das is an Australian-based former banker and corporate treasurer turned academic and author. His most recent book is The Age of Stagnation: Why perpetual growth is unattainable and the global economy is in peril.

Some of his earlier writings, from 2005 and 2006, proved prescient about the risks in derivatives that became more widely apparent in 2007. Given this past form, many investors are now listening carefully to Das’s fears about the global economy being over-leveraged.

To put his concerns about the build-up of debt into context, more than 20 countries now carry debt-to-GDP ratios above 200 per cent, with global debt having grown by $57 trillion, or 17 per cent of world GDP, since the GFC.

Unsurprisingly, Das says, there is uncertainty over these numbers’ short- and longer-term impact on traditional financial markets and lending practices.

What’s arguably contributed to the financial markets’ highly distorted view of economic reality, Das adds, is the longstanding fixation with using debt to buy existing assets, rather than to invest in productive businesses.

He explains: “Somewhere along the line, the world became one big carry trade. Here in Australia, people can buy anything they like with borrowed money, and everyone looks rich on paper. But finding a buyer down the track to realise the gain is becoming increasingly problematic.”

Post-war model ‘broken’

What we’ve been left with, Das says, is a world that continues to deny that the post-war economic model is fundamentally broken.

“While most [chief investment officers] continue to target historical returns of 6 per cent to 8 per cent, or 4 per cent above inflation, it’s less likely that markets will resume delivering these outcomes at some future stage,” Das says. “Similarly, chasing higher yields without understanding the higher risks is like trying to pick up a gold coin in front of a speeding train.”

He says the key problem confronting institutional investors today is that there are many more unknown unknowns than at any time in recent history. As a result, investment chiefs now find themselves trapped in a world where they’re incapable of grappling with fundamental financial problems they’ve collectively created over the last three decades.

“CIOs are playing musical chairs, and when the music stops again, it will do so in a far more radical way than it did during the GFC,” he predicts. “Most growth generated over the last 30 years is due to excessive debt, financial imbalances, and a cycle of entitlement that appears impossible for policymakers to roll back; while companies have been more concerned about financial engineering than real engineering.”

What bothers Das just as much as the mounting debt levels is that the worldwide growth in equity prices since 2009 remains hugely uneven. For example, in the US, the S&P 500 has tripled since the nadir of the GFC; while here in Australia, the ASX All Ordinaries Index still trades about 16 per cent below its peak of 6873 points on November 1, 2007. Japanese equities are lagging even more, with the Nikkei Index trading slightly down from where it was back in 2000.

Das suspects growth and inflation will remain low and volatility variable, with sudden and unpredictable “melt-ups and meltdowns”. Within this environment, he urges CIOs to get better at tapping into the brains trust behind central bank policy.

Mandated traps

Unlike superannuation and pension funds, which are locked into particular ways of investing, courtesy of their mandates, family offices have successfully learnt from their past mistakes, Das says, to emerge amongst today’s best investors. What they’ve understood, he explains, is that returns require getting close to real income streams.

As a result, what they’ve successfully done since 2008-09 is switch their previous 80 per cent exposure to public assets into private assets.

“The trouble is, CIOs, et al, can’t do that because their mandates simply don’t allow them to,” he says. “They’re fundamentally flawed because within this bi-polar macroeconomic environment, normal investing rules don’t apply.”

While dealing with the prevailing macroeconomic dynamics isn’t easy, Das recommends CIOs get better at capitalising on whatever conditions the market throws at them. While there’s no such thing as magic pudding, he says the onus is on CIOs to move away from public markets and renegotiate their investment decision rationale.

Within an environment where indices don’t make sense, he recommends moving more towards absolute returns and income than capital gains.

“Assuming that CIOs’ hands remain tied and they don’t loosen their mandates, their focus should be on things they can do smarter and learning what they can live with,” Das says. “The alternative is to admit this is an uncertainty that you simply can’t manage and return money to investors.”

While few fund managers are considering such a bold move, a growing number do share many of Das’s concerns about global debt levels and the challenges they pose to the outlook for fixed income markets.

Focus on absolute returns

Apollo Advisors head of yield product development Seth Ruthen says that to be successful in the new environment – characterised by fiscal policy exhaustion, low growth, low inflation, low GDP and low interest rates – managers need to think about different types of risks than they are used to and develop strategies diametrically opposed to those that worked a decade ago.

Ruthen urges institutional investors to seek out managers who can create multi-dimensional opportunities beyond duration, credit quality and volatility.

“That also means moving into unconstrained environments more likely to deliver absolute returns,” he says.

Similarly, Brandywine Global portfolio manager and head of high yield, Brian Kloss, argues that an unconstrained holistic approach should help generate both absolute returns and a stable level of income, while reducing correlations to lower volatility.

In addition to looking beyond the traditional asset allocation approach, Kloss suggests investors look broadly across fixed income markets and sectors to create a multi-asset class fixed income portfolio.

“This return stream should originate from differentiated sources of alpha across multiple fixed income asset classes, including currencies, sovereign bonds, investment grade and below-investment-grade credit, structured credit and bank loans,” Kloss says.

Rethink the investment process

Beyond urging a move towards absolute returns and income, Das also recommends CIOs take steps to get on the right side of future M&A activity and lower their exposures to sectors that will ultimately be killed off by disruption or regulation.

“Instead of overestimating future upside from either emerging markets or geopolitical risk, a much bigger issue confronting CIOs is how to be rewarded for funds under management, especially when ETFs are killing them on the fees [and sometimes on the performance] front.”

To create an environment where CIOs are considerably closer to free cash flow, Das recommends rethinking the investment process and the ability to preserve capital while also generating income and future capital growth. It’s also important, he adds, that CIOs get better at developing strategies around what a protracted low-growth and low-inflation environment is going to offer.

But given there’s little room for rates to go much lower, Ruthen says expanding the opportunity set to include things beyond what’s easily accessible or index-oriented – plus having the discretion to respond quickly across asset classes – has surpassed duration as the most important factor for managing risk.

“That means being able to buy debt off other people’s balance sheets, creating debt within the right parameters, using illiquidity in a prudent manner and getting paid for it in the right way,” Ruthen says. “If CIOs don’t have the skillset to reorient the business around new opportunities, they’re at a real disadvantage.”

 

Jaap van Dam, principal director of investment strategy at PGGM, one of the world’s largest asset owners known for its commitment to long-horizon investing, was once asked what he called “the million-dollar question”: Can we be reasonably certain that we will be rewarded for being a long-horizon investor?

As van Dam rightly put it, the answer to this question will determine whether long-horizon investing will take off among asset owners. Because, if there’s no reward, then why bother?

I would propose that the answer is a resounding yes. And that response is supported by the work we have done at the Thinking Ahead Institute, in particular within the long-horizon investing working group.

In our paper, The search for a long term premium, we conclude that a sizeable net long-term premium of 0.5 per cent to 1.5 per cent a year – depending on investors’ size and governance arrangements – can be exploited by investors with the appropriate mindset and skillsets. (See Long-horizon premium: up to 1.5%).

Hunting for evidence of long-term premia is easier said than done. In an ideal world, we would run a regression of net returns against time horizons. Sadly, to our knowledge the data to run such a regression does not exist due to a number of obstacles, such as the difficulty in accurately measuring investors’ the time horizons.

As a result, we used an indirect approach, based on the belief that long-horizon investing offers both return opportunities and the chance to reduce drag on returns. This led to the identification of eight building blocks of long-horizon value. Each is practical to implement, albeit with changes to the investment process. Together, they provide evidence of a sizeable premium from long-horizon investing. Some provide return opportunities and others create chances to lower costs.

Liquidity provision and other opportunities

Let’s start with return opportunities. The first relates to a study that examined more than 2000 highly intensive engagements with over 600 US public firms between 1999 and 2009. The study showed that engagements with investee companies generate, on average, positive abnormal returns of 2.3 per cent over the year following the initial engagement – clear evidence of the benefits of being active owners to encourage investee companies to take long-term approaches.

The next two return opportunities relate to liquidity. When investors are willing to pay for liquidity – in other words, sell assets below fair value – someone on the other side of the trade gets paid. One study suggests that long-horizon investors have the potential to earn additional returns of 1 per cent a year at the expense of shorter-horizon investors by providing liquidity when it is needed most.

Another aspect of liquidity involves the illiquidity risk premium, which is well established as a source of return for long-horizon investors. When investors accept illiquidity, they accept greater uncertainty because they are less able to liquidate the asset. The longer the capital is tied up, the more return investors expect by way of compensation. Academic studies point to a range of 0.5 per cent to 2 per cent a year for this particular premium – and even higher returns might be available to very long-horizon investors.

A fourth return opportunity for long-horizon investors comes from exploiting various mispricing effects via smart betas. Decades of data suggest that this can add more than 1.5 per cent a year, relative to the cap-weighted index.

Finally, understanding the long horizon can help funds take advantage of thematic investing. Many hold a belief that education, renewable energy, ageing, technology and other themes are key value drivers for investors. However, lack of consistency in implementation has prevented researchers from finding empirical evidence that a thematic approach works. Even so, belief in thematic investing is strong: 93 per cent of attendees at the 2016 Thinking Ahead Institute New York roundtable believed that it was possible to enhance portfolio value by investing thematically.

Lower turnover and other potential savings

Now let’s examine how a long horizon can help reduce drags on returns.

A study of more than 400 US plan sponsor ‘round-trip’ decisions (the firing and replacement of managers) between 1996 and 2003 compared post-hiring returns with those the fired managers probably would have delivered. It suggested that by replacing their investment managers, the plan sponsors gave up a cumulative 1.0 per cent, on average, in the three years following the change – a dear cost they paid for buying high and selling low that can be mitigated by a long-horizon mindset.

Open-ended fund structures, despite the flexibility they provide, might not be fit-for-purpose for long-horizon investors, who do not require nearly as much liquidity as short-horizon shareholders and can, therefore, take advantage of closed-ended opportunities. In open-ended structures, long-horizon shareholders essentially subsidise their short-horizon peers’ liquidity needs. One study found that liquidity-driven trading in response to flows (in particular redemptions) reduced returns in US open-ended mutual funds by 1.5 per cent to 2.0 per cent a year from 1985-90.

Last but not least, long-horizon investors can save on transaction costs by avoiding unnecessary turnover.

An advantage for larger funds

Capturing the benefits of a long horizon will probably require investors to expand their skillset and make a major shift in mindset. In many cases, it will entail incremental spending; for example, expanding investment expertise in active ownership by hiring a specialist or increasing the number of trustee meetings to strengthen belief in long-horizon investing.

The potential benefits of this additional spending are in many cases enhanced returns. In The Search for a Long-Term Premium, we examine two hypothetical pension schemes to develop a reasonable estimate of the potential long-term premium in practice.

The smaller fund focuses its long-horizon efforts on avoiding costs and mistakes. It reduces manager turnover, avoids chasing performance and forced sales, and moves part of its passive exposure into smart beta strategies. The rationale is: If you don’t have the resources to win big, at least don’t lose. The net benefit of these efforts is potentially an increase in investment returns of about 0.5 per cent a year.

The larger fund has the governance and financial resources to consider all available options for capturing premia. It introduces long-horizon return-seeking strategies while reducing its exposure to mistakes and costs. The net uplift to returns is potentially about 1.5 per cent a year.

In the investment world, where there are few universal truths, it would be hubristic to conclude that we have proven the existence of the long-term premium. We are, however, reasonably certain that the potential return enhancements of long-horizon investing substantially outweigh the cost of addressing its challenges.

If such a premium exists, however, why are institutional investors not exploiting it already? Our next challenge is to understand the potential obstacles and, finally, present a range of practical solutions to allow investors to build a long-term orientation and access that premium.

Liang Yin is senior researcher at the Thinking Ahead Group, an independent research team within Willis Towers Watson, and executive to the Thinking Ahead Institute.

 

EDHEC Infrastructure Institute is releasing 384 indices covering private infrastructure equity and debt investments. We hope these results will help dissipate the confusion created by #fakeinfra.

Almost every day, asset owners are presented with new opportunities to invest in ‘infrastructure’. The appeal is always the same: yield, stability, a degree of portfolio diversification, perhaps even inflation hedging.

But that infrastructure label has been stuck on more than one tin. A serving of infrastructure can now come in many forms: from private equity funds with various horizons and mandates, to ETFs and other funds of publicly traded equities, to green bonds or infrastructure real-estate investment trusts. Many investment products may have a new infrastructure look but it is possible that they have nothing new or special to offer – just confusing repackaging.

‘Listed infrastructure’ is #fakeinfra

Listed infrastructure is a case in point. Our recent study of the (absence of) unique characteristics among 22 listed infrastructure proxies is published in a peer-reviewed journal. A key finding stands out: there is no such thing as a listed infrastructure asset class.

This study highlights the importance of discussing the existence of new asset classes in a total portfolio context. Using mechanical stock filters or industry-provided thematic indices, we conducted 176 mean-variance spanning tests – both before and after the global financial crisis – in global, US and UK markets, and found zero evidence that focusing on ‘listed infrastructure’ creates any new and persistent diversification benefits for already well-diversified investors.

It’s #fakeinfra. It’s presented to investors as an opportunity to gain exposure to something new or rare, but has, in fact, always been available; that is, it is already spanned by existing capital-market and other instruments. Today, a listed infrastructure fund is just an active equity fund with a narrow industrial focus. It is an alpha-driven product, often mislabelled as a new form of beta. It is not what investors need to better understand the potential role in their portfolio of infrastructure and real-asset investing.

#Fakeinfra looms beyond the listed equity space as well. Reporting and valuation in private equity make it difficult for investors to find the products they need. Ill-defined terminology makes this problem worse. (Is it helpful to talk of ‘core’ and ‘core+’ infrastructure assets? Unlike real estate, infrastructure is no store of value; it needs to be used to have value.)

Real results, real assets

Now, thanks to an EDHEC initiative with industry support, the growth of #fakeinfra, listed or not, may begin to abate.

The 384 indices we’re releasing – in two series of 192 indices each – show the risk-adjusted performance of hundreds of private European infrastructure equity and debt investments, going back to 2000.

Thanks to the largest database of infrastructure investment information in the world and a unique asset pricing technology designed to estimate the performance of private, highly illiquid assets such as infrastructure debt and equity, EDHEC can produce the risk-adjusted performance metrics investors and regulators need to understand private infrastructure debt and equity as asset classes.

The news is good. We find that investing in private infrastructure assets can indeed generate out-performance, diversification or better duration hedging. It can have lower value-at-risk than major market benchmarks (suggesting a better prudential treatment under Solvency-II, for example) and its Sharpe ratio can be higher than that of indices typically used as market references.

Our indices also show that while individual investments can be quite volatile, most of this volatility is project-specific; in other words, in larger, more balanced, portfolios it is diversified away. As a result, the Sharpe ratio of the infrastructure broad market index is attractive.

Today, these indices are not directly investible. However, tomorrow they will grant investors and managers access to infrastructure investment on a well-diversified basis that will make all the difference between an attractive investment opportunity and a few highly concentrated bets, which may or may not turn out well.

In a world where proper metrics have become possible and better infrastructure investment products can be imagined, #fakeinfra can become a thing of the past, and real asset investing can begin to enter adult life.

Frederic Blanc-Brude is director of the EDHEC Infrastructure Institute.