Aurora Borealis
1 February 2013 CFA Institute Journal Review

The Risk Profile of Infrastructure Investments: Challenging Conventional Wisdom (Digest Summary)

  1. Andrew Boral

The authors conduct a thorough examination of the infrastructure investment landscape. They focus on volatility comparisons between infrastructure sectors, other industries, and market returns. Controlling for other risk factors, they determine that although infrastructure is low risk and adds to diversification, it does not lead to lower total corporate risk.

What’s Inside?

Conventional wisdom holds that infrastructure investments are safer than many other asset classes and that the addition of these assets enhances diversification. The authors develop these ideas and confirm that infrastructure has a low correlation with other industries.

They introduce a liquidity adjustment for dealing with many illiquid infrastructure assets. With this tool, they determine that idiosyncratic risk remains strong in these investments despite the diversification benefits. This finding allows investors to better understand the role that infrastructure funds should play in their portfolios.

How Is This Research Useful to Practitioners?

Infrastructure investments are interesting to many pension and insurance funds. These funds demand long-term investments that are low risk with reasonable returns to match their long-term liabilities. The authors address the question of whether infrastructure investments are low risk in many different ways. They ultimately find that although infrastructure investments diversify a portfolio, they do not lead to lower total corporate risk.

These investments have a considerable amount of heterogeneity. The authors consider three broad sectors: telecommunications, transportation, and utilities. They find that utilities are the least risky sector, followed by transportation and then telecommunications. Other significant risk factors are geographic region, asset maturity, and regulatory regime.

If idiosyncratic risk does remain, investors should require cost of capital premiums. Investors must also use more sophisticated mitigation techniques.

How Did the Authors Conduct This Research?

The sample includes 1,400 listed infrastructure investments across a wide range of sectors. Data are gathered from multiple sources. The time period for the sample can be as large as 35 years (January 1975 through December 2009), with an average of 12 years of data available. The authors strive to include all types of investments within the three sectors—utilities, telecommunications, and transportation—but they do make some prudent exclusions. For example, the final sample includes equity-only assets and firms that have actual physical infrastructure assets (e.g., rail tracks and telecom cables). But there are no geographic restrictions, so a global sample is used.

From these data, the authors conduct a two-part analysis. The first part is a descriptive analysis, in which volatilities are compared between global market indices, broad infrastructure sectors, and a more granular industry breakdown. The second part tests the conclusions reached in the descriptive analysis with a regression analysis. The regressions incorporate common firm-specific factors in addition to the infrastructure-specific volatilities. The regression enables further discussion of the sources of risk in infrastructure investing.

Abstractor’s Viewpoint

The authors conduct a reasoned analysis of the risks involved in infrastructure investing, which is a timely topic. Pension and insurance funds demand long-term assets that have desirable risk and return profiles. The authors further this objective by outlining a framework for analysis of the sources of risk.

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