Is rolling stock infrastructure? Investors debate definition of asset class

How many assets does an infrastructure portfolio need to be sufficiently diversified? Most institutional investors would say between 20 and 50, according to a recent survey by EDHECinfra and the Global Infrastructure Hub. But this is not enough according to Frédéric Blanc-Brude, the director of EDHECinfra, the organisation that has been striving over recent years to transform the way the asset class is measured and classified.

Speaking at the annual EDHECinfra Days Conference in London on Friday, Blanc-Brude wondered if those answering the survey were referring to “a vague memory from their MBA days” that owning 40 to 50 stocks ensured a portfolio was diversified. EDHECinfra research suggests it should be more in the region of “several hundreds of assets”, he said, while admitting “this is difficult to achieve”.

But Blanc-Brude was clear that, once further research uncovered the reality about diversification in infrastructure markets, “new products will appear”. He said: “The value proposition of offering exposure to 20, 50 assets will become clearer.” This could have big implications for the status quo of the industry. “It means probably that the larger asset managers will have a competitive edge,” he said. “It means there will be some consolidation.”

Blanc-Brude also ventured that it could be a boon for the fund-of-funds business, which could “become the dominant model – if you can get the fees right”. He added: “This will be the way for most investors to access infrastructure in a well-diversified manner.”

Not everyone is likely to agree with this prognosis. Proponents of listed infrastructure would point to a highly liquid and diverse global opportunity set readily available to investors in the public markets. EDHECinfra stirred up controversy a couple of years ago when it dubbed listed infrastructure “fake infra”, an argument that has been rebutted and re-iterated within the pages of IPE Real Assets.

The subject arose again, but this time in relation to investors using listed infrastructure benchmarks for private infrastructure investments. Blanc-Brude said this was an “odd choice” and one that can “lead to disagreeable consequences”. He said EDHECinfra continued to update the numbers behind its research that shows listed infrastructure stocks are highly correlated with the wider equity markets.

According to EDHEC’s survey, however, the majority of investors use absolute-return benchmarks for infrastructure, often to outperform inflation. The audience learnt that California State Teachers’ Retirement System (CalSTRS) and Ontario Teachers’ Pension Plan (OTPP) both fall into this camp, using benchmarks set at several hundred basis points above the consumer price index.

Of the investors in the survey that use absolute-return benchmarks, 90% acknowledge they are inadequate, and both Paul Shantic and Mark Blair, directors of CalSTRS and OTPP, respectively, indicated that their benchmarks could one day be replaced.

According to Shantic, who oversees $8.8bn of inflation-sensitive investments at CalSTRS, nearly two-thirds of which are take the form of infrastructure holdings, is planning to staff up for the asset class. He expects the infrastructure allocation to increase once an ongoing asset-liability study is completed and the pension fund is looking to be able to analyse individual deals itself.

The plan, which includes a greater use of co-investments and partnerships, runs somewhat counter to Blanc-Brude’s earlier vision of investors becoming more removed from individual assets, seeking greater diversification and, potentially, adopting fund-of-funds managers.

Shantic explained that CalSTRS already has people capable of carrying out due diligence on funds, strategies and teams, but will look to bring in those who can analyse assets. But CalSTRS is not going to go all the way and seek to “emulate the Canadians and Australians”, long associated with large, direct exposure to infrastructure assets, he said. “We are not looking to replace managers, we are looking for a better deal.”

He added: “We are a long-term holder in the infrastructure space. We want to buy and hold it, and sit on it and take the cash flow from it. We want to control our own destiny.”

Defining moment for asset class

Shantic is supportive of EDHECinfra’s efforts to provide more appropriate infrastructure benchmarks for institutional investors, and said he was interested to see how its work on debt and ESG indices would progress. CalSTRS, like a number of organisations, has adopted The Infrastructure Company Classification Standard (TICCS), which defines and segments the asset class so that custom benchmarks can be built, and Shantic is on the 16-strong TICCS review committee.

With TICCS, EDHECinfra is hoping to replace unhelpful definitions in infrastructure that have been copied and pasted from other asset classes like real estate and private equity. The use of core, core-plus and value-add, for instance, long-established in real estate circles, is not helpful for understanding risks inherent in investments and strategies, EDHECinfra argues.

Shantic said CalSTRS uses terms like core and core-plus internally. “We all know exactly what that is,” he said. “When I communicate with my board members, I will say ‘core, core-plus’, and they will nod their heads, because they’ve heard it in real estate.” But he expects this to evolve. “What I think is going to happen is that the story is going to change as more research is done.”

TICCS, which is currently open for consultation, applies four pillars: business risk (contracted, merchant, regulated); industrial activity (transport and renewable energy, for instance); geo-economic exposure (global versus regional versus national), and corporate governance.

The second pillar, which currently includes eight industries, is the one that prompted the most conversation. It is clear that infrastructure is evolving – often through technology, so that some of today’s infrastructure assets simply were not part of the opportunity set in the past.

There is much debate about what assets should be included in the infrastructure asset class. Boe Pahari, global head of infrastructure equity at AMP Capital, said the fund manager was investing in things today that it would not have been able to a few years ago, from battery storage and combined-cycle gas turbines to the latest fibre-optic technology.

Today’s technological disruption is likely to become tomorrow’s infrastructure, he said, likening the process to the Wright Brothers having no idea at the start of the 20th century that their aircraft invention would lead to the creation of airports around the world. AMP Capital today invests in 10,000 miles of fibre optics in the US, Pahari said.

“Capturing the disruption is an opportunity. If you leave it too late it becomes a threat,” he said. “It’s important as investors to capture those trade winds, to capture those disruptions early to see what the trend is and what will become infrastructure.”

During a debate about defining the asset class and TICCS, two types of assets proved to be somewhat divisive. Rolling stock was one, which Blanc-Brude suggested should not be included along with aircraft and ships, on the basis that infrastructure is assumed to “bolted to the ground”.

However, Marija Simpraga, infrastructure strategist at LGIM Real Assets, said: “I would challenge that a little bit. If you look at rolling stock in the UK – very literally it is a mobile asset, but you can’t take trains out of the UK and put them on the French rail track.” She added: “If you look at the stability of cash flows, if you look at the technology risk, if you look at the many fundamental characteristics that infrastructure investors are looking for, rolling stock very much fits that definition.”

There was a similar theme with property registries, such as those in Australia that have been sold to infrastructure investors in recent years. Steven Hong, senior manager at the Global Infrastructure Hub, said these were not physical assets but “had the characteristics of infrastructure”.

Blanc-Brude worried that, although a land registry business might have “characteristics that are in common with infrastructure”, in terms of financial outcomes it is a completely different asset. There was a debate about how important this was.

“At the end of the day we care about what the outcome is for our clients,” Simpraga said. “We will take a slightly more flexible approach in the sense that we will look at assets on the merit of what they deliver, what they add to the portfolio, how they behave and what the impact will be on the overall risk-return profile by adding them.”

Rick Walters revealed that GRESB, a real assets sustainability benchmark which has adopted TICCS, is including land registries, rolling stock and shipping in its coverage. The infrastructure director said: “We’re not making a view on that, we’re just catering for our customers.”

Avi Turetsky, managing director in the quantitative research group at Landmark Partners, said: “This may be a question that the market will decide, as there is more data… On this stage 10 years from now, we will probably have a much better answer about whether it’s infrastructure or not.

“It’s pretty clear to me that there are a lot of things that people try to call infrastructure but really are not.” But, he said, there are a lot of “edge cases” where the jury is still out. “I am interested in finding out”.

Blanc-Brude reminded the audience that the consultation was still open. “Let us know if you think rolling stock should be included in the infrastructure definition,” he said.

The infrastructure asset class is having its defining moment, literally.