This blog was originally published in IP&E Real Assets.
It’s time to stop saying apples are just round pears
Infrastructure as an asset class has evolved over the past decade at a speed that has brought its own challenges. One of those is taxonomy. As it has expanded and grown in popularity, it has borrowed classifications and definitions from private equity and real estate. What it needs, instead, is its own unique taxonomy, one that describes the characteristics of infrastructure, rather than how it differs or resembles other assets. Until they are given a solution to this problem, asset managers will struggle to assess what is available and how it can be incorporated into their strategies.
Recently asset managers have launched products offering value-added strategies as increasingly the line between private equity and infrastructure has blurred. The trouble with inherited labels, however, is that they provide no clear definition of infrastructure and so fail to encompass all the dimensions and risk profiles of the asset class. Consequently, they can often give managers licence to make spurious investments.
Investors also need better definitions for what core, core-plus, value-add and super-core products encompass. Generally these act as a way for managers to justify return targets without materially changing their investment techniques. Managers find themselves stretching boundaries, such as investing in real estate assets with infrastructure value-added labels slapped on top.
The infrastructure sector does itself a disservice without a clear structure and definition of the strategies it can offer investors. Without a proper taxonomy providing useful criteria, asset managers will struggle to structure the solutions that investors need.
Finding definitions that are actually useful
So what is infrastructure? There are several definitions. The OECD and World Bank, for example, use definitions based on public policy. Regulators, meanwhile, focus on what infrastructure ‘is like’ in order to qualify it under various prudential frameworks. Finally, under Basel II and Solvency II, regulators apply definitions that try to differentiate how infrastructure investments differ from corporate equity or debt. All three approaches fail to provide a definition unique to infrastructure.
None of these classifications encompass all of the characteristics of infrastructure, from business risk profile to industrial expertise. Without this, investors continue to buy into vague strategies with no deep understanding of how infrastructure investments are concentrated in their portfolios.
We start with the characteristics that investors actually care about
What if we had a classification that embodied all the characteristics of infrastructure? The EDHEC Infrastructure Institute, as part of its work to build performance benchmarks for investors in private infrastructure debt and equity, has launched the Infrastructure Company Classification (TICCS) to do just that. Taking existing definitions and perspectives into account, EDHEC has created multi-dimensional criteria to help classify and define the asset class. TICCS is compatible with the Basel II and Solvency II definitions of infrastructure, which focus on risk profile, but in addition it also incorporates the unique characteristics of infrastructure.
TICCS comprises four pillars to structure the infrastructure asset class and provide a frame of reference for asset owners and managers. we have designed it to be compatible with other standard investment classifications and take into account the evolution of the asset class.
Infrastructure project companies typically encompass a long-term contract between investors and the public or private-sector to develop a single project. Their financial structure typically minimises their incentives to take risk. Projects tend to be highly leveraged, which plays an important disciplinary role as well as providing a signal of creditworthiness.
An infrastructure corporate, however, is still akin to a traditional corporate. Managers have the freedom to make investment decisions that change materially and strategically over time. They are also free to change their financial structure as they adapt to market or economic changes and, to that end, can use multiple sources of public and private financing. They may use debt to increase returns on equity and creates incentives to take risks.
The right definitions provide investment guidance
It is vital that infrastructure differentiates itself from private equity and real estate using clear definitions and structure. Without this, investors will be sold mistruths and will never truly be able to integrate infrastructure into their wider portfolios.
TICCS enables investors to group infrastructure investments in a more structured way. It can define investment styles, helping asset managers to design strategies that utilise the characteristics of infrastructure more effectively. In turn, when defining a benchmark for each strategy, TICCS provides an ideal methodology. And it will enable asset owners, managers, regulators, banks and advisers to structure the sector, and document the investable market in years to come.
