In this paper, we examine the drivers of the volatility of unlisted infrastructure equity investments, that is, the reasons why the market prices of such investment can and do vary over time.

The volatility of infrastructure equity investments is the risk which investors take to receive a reward for holding such assets. A robust measure of this risk and its drivers is an essential part of the inclusion of infrastructure investments in the portfolio, from strategic asset allocation to risk management and reporting, to manager compensation.

However, measuring this risk is difficult because the only available data is often limited to quarterly appraisals that do not reflect the current state of market prices but are instead ‘stale’ i.e. backward-looking and lead to very ‘smooth’ returns, exhibiting highly unrealistic (low) levels of risk per unit of return. Appraisal-based indices typically report unrealistic total return volatility in the 2-3% range, leading to very high and unrealistic risk-adjusted returns (Sharpe ratio above 3).

Our analysis uses the EDHECinfra database of unlisted infrastructure equity investment data, which covers hundreds of firms over 20 years and a new approach to measure the market value of these investments over time. Thanks to this technology, which predicts actual market prices very precisely, it is possible to measure the variability of unlisted infrastructure equity prices and to describe its fundamental components. The market value of these investments is determined by the combination of expected cash flows (dividends), and a discount rate that combines a term structure of interest rates (the value of time) and a risk premia to compensate investors for the uncertainty of the future payouts. On average, the applicable market discount rate is also a reflection of investors’ expected return.

Using our approach to mark unlisted infrastructure to market, we find that the combination of changes in expected dividends (e.g. following a change in demand for transport services or energy) andofchangesin expected returns lead to a level of total return volatility in the 7-12% range. The resulting risk-adjusted returns are realistic while still attractive.

Looking at the components of the change in market value of unlisted infrastructure, we find that infrastructure equity risk can be driven at least as much by changes in expected cash flows than by changes in expected returns. This is an important and sometimes neglected aspect of the risk of investing in infrastructure: while cash flows are typically understood to be quite stable, the long-life of infrastructure investments makes their value sensitive to changes in discount rates. Therefore, assessing the evolution of investors’ expected returns in unlisted infrastructure equity is essential to arrive at robust measure of risk at any point in time.