By David van Bragt, Investment Solutions Consultant – Aegon Asset Management
We base our analysis on the available benchmark data for this asset class. Since the available data is limited, we also performed several sensitivity analyses.
Infrastructure relates to equipment, facilities and networks providing essential public services. These real assets generate predictable long-term contracted and/or regulated revenues. The asset class is supported by structural trends like the EU and national governments committing themselves to a transition to clean and renewable energy.
Examples of infrastructure investments are investments in wind and solar energy, environmental projects with a focus on recycling or re-using waste, and reducing the carbon footprint with innovative transport projects. Focusing on infrastructure debt, so excluding infrastructure equity, the total amount of investments in the EU was €70 billion in 2017. Germany, France, Italy, Benelux, Spain and Portugal represent 83% of the euro-denominated market. The UK is the largest European market.
Economic scenario mode
Our economic scenario model for infrastructure debt is based on benchmark data from the EDHEC Infrastructure Institute. This institute has developed an extensive suite of private equity and debt indices. We use their benchmark data for project finance debt in continental Europe. This index includes 89 value-weighted live exposures to senior private debt, representing approximately €35 billion equivalent of market value. The historical performance of this benchmark is shown in the figure below, compared to the performance in this period of an (investment grade) euro credits benchmark and a euro core sovereign bond benchmark.
Figure 1: Infrastructure project finance debt benchmark returns in comparison with returns on euro credit and euro core sovereign bonds. Sources: EDHEC Infrastructure Institute, Merrill Lynch, Barclays.
Infrastructure debt has a high historical return in combination with a low volatility. The correlation with euro credits is relatively high, as is the cross correlation with the past year’s return on euro sovereign bonds. This is an indication that the impact of interest rate movements may be absorbed by private infrastructure debt with a certain time lag. The high historical return for infrastructure debt is replaced in our scenario model by a more moderate return assumption.
An overview of the characteristics of our economic scenarios is given in the table below. We use 1000 scenarios with a length of 15 years each. Notice the attractive return/risk characteristics of infrastructure debt, in comparison with other fixed income categories and equities.
Table 1: Return and risk characteristics of the different asset classes for the next 15 years. Sources: Aegon Asset Management, La Banque Postale Asset Management, Ortec Finance.
Impact of adding infrastructure debt
Our analysis shows that an allocation of 5% to infrastructure debt, which is funded by selling 5% of euro core sovereigns, leads to an increase of the average return on assets/liabilities with 0.3%-point (per year). A somewhat smaller effect is visible when funding infrastructure debt with credits or mortgages. A slightly lower average return occurs when we fund infrastructure debt with equities. We see similar effects for the 5% most positive and negative scenarios, except when we substitute equities with infrastructure debt. In this case the return in the most positive scenarios decreases (with 0.6%-point). On the other hand, results improve (with 0.5%-point) in the most negative scenarios.
We also carried out several sensitivity analyses, such as a higher volatility or a lower expected return for infrastructure debt. Generally speaking, this also leads to a positive effect on the portfolio level in these alternative cases.