The absence of an unlisted index has been one of the biggest obstacles for institutions wishing to invest in infrastructure. But this will not be the case for very long, says Richard Lowe

How do you demonstrate your relative performance? This is a question that unlisted infrastructure fund managers are increasingly coming up against from leading institutional investors.

A short, candid answer would be: with great difficulty. Unlisted infrastructure funds are a relatively new investment class and there is very little in the way of hard data available to benchmark general partners.

For the moment, there are not enough performance numbers to put the hopes and expectations of funds raising capital into a more empirical context. Current methods, such as looking at relative performance over a regional inflation index, are generally inadequate for the long term.

The global pension fund clients of consultancy Watson Wyatt generally fall into two categories at the moment: those that aim to achieve, in other words, inflation-plus-something and those targeting an absolute return.

What the ‘something' constitutes depends on what type of infrastructure assets are being invested in, with low-risk public private initiative (PFI) projects, for example, targeting a smaller return relative to inflation than the more value-added or developmental end of the spectrum. The latter approach could be targeting, net of everything 10%, 12% or even 15%.

"Investors are coming at it in different ways, depending on their own objectives and where they see infrastructure fitting into their overall strategy," says Jane Welsh, senior investment consultant at Watson Wyatt. "But it is tough, because there are no peer groups, there are no long histories, there are no decent indices as such that can be used, particularly on the unlisted side. People are just feeling their way really as to how to benchmark these managers."

Watson Wyatt analyses the returns in unlisted infrastructure funds "when they become meaningful", which, as is the case with private equity, is usually a number of years into the life of a fund. However, Welsh stresses the importance of looking at a multiplicity of factors, such as: "The rate at which the money is being put to work; is it slower or faster than we'd hoped?

Are they sticking to the strategy they said they were going to follow - do they seem to have deviated from that? Is the team staying together… are they building the portfolio as expected?"

Indeed, there are a number of factors to consider when assessing unlisted infrastructure funds, not just headline performance figures. However, that is not to say there is not a dire need for unlisted infrastructure benchmarks if the sector is to develop towards its true potential.

There are listed infrastructure indices in existence, but as Rob Treich, principal at Mercer, explains, pension funds are generally seeking pure infrastructure exposure without the volatility and "equity risk" that comes with listed investments. It should follow then that such indices are inadequate for their needs."There is not enough verifiable data around in the infrastructure space to be able to model the expected risk and return characteristics of the asset class with a high degree of conviction," Treich says.

Fortunately, he expects to see unlisted indices appear in the not-too-distant future. "There are now enough funds out there that have been around long enough that it should be possible to construct that type of index."

Among the organisations now planning to create an index is Investment Property Databank (IPD), which has been collecting data from fund managers. The project is being run from its office in the US and is essentially a response to the growing interest it has received from traditional commercial property clients that also run infrastructure funds.

"They were interested in trying to do the similar sort of analysis we do for the commercial property but on the infrastructure side," explains Simon Mallinson, head of US services at IPD.

What pension funds always require, he says, "is some sort of benchmark or yardstick to compare the performance of funds against. The only things out there were listed infrastructure indexes, which… while they show what listed infrastructure is doing, you can't drill down into it and look at what a toll road is doing, what a bridge is doing or what an airport is doing. All you can do is the top-down approach. What IPD is doing is to come up from the bottom in a similar way to what we do in our property indexes and property benchmarking service."

Although the project is being co-ordinated in the US, the index is intended to be global in scope and eventually even offer sub-sections for the various infrastructure sectors. Having said this, it is still early days; IPD has thus far been fairly quiet in terms of promoting the project, instead focusing on working with clients at the outset. And fund managers have been largely keen to help, Mallinson says.

Certainly, Treich expects that fund managers would want to provide data if an index was created. "They probably have a vested interest in ensuring the data is at least reasonably representative of what is going on in the asset class," he says.

Mallinson supports the supposition, stating that fund managers "see this as useful to them". He continues: "They need a benchmark. They need some recent market research that helps them sell infrastructure as a product and they seem happy to work with us at the moment."

IPD's aim is to be able to provide some "initial figures" for its clients by the end of the year, or early 2009. Expect to see more being announced on the topic in the first quarter of next year.

"We are trying to push forward as quickly as possible, because it is now that people are interested in this area," Mallinson says. "If we don't strike now, someone else will come in and try to do it."

While IPD and other companies may well be making the first important steps in this space, it should be remembered that unlisted infrastructure performance measurement and benchmarking will remain in its infancy for some time as the asset class is naturally a long-term investment proposition.

"It will take some time for data to become mature enough to be really useful," Treich says. "You cannot just plug a number into an optimiser for infrastructure and see what comes out the other end. You have to apply some judgement and look at the individual characteristics of the funds."