Infrastructure Investment as a True Portfolio Diversifier

Abstract

Often compared to real estate for its inner characteristics, infrastructure (e.g., railways, bridges, ports) is an alternative asset deeply involved in the growth and development of the countries where it is implemented; infrastructure is also intertwined with the political and economic environments of these countries. Developing and developed countries face different problems in terms of infrastructure investments. European countries are improving quality of life with better transportation networks, access to renewable energy, and social infrastructures. Countries try to achieve economic growth through the improvement of economic infrastructure. In developing countries, it is social infrastructure (e.g., hospitals, schools, desalination plants, waste and water treatment plants) that dominates the field, with the goal of achieving a higher level of economic and social development. Infrastructure investments have specific features that differentiate them from traditional assets, among them low volatility of cash flows, indexation to inflation, predictable and steady stream of cash flows, large capital outlays at the start, and nearly nonexistent capital cash outs thereafter. Investment in infrastructure was previously considered to be low risk and low return, although this depends on the sector chosen for investment. This article aims to compare a diversified portfolio, namely the Yale endowment fund investment portfolio, with a portfolio fully invested in infrastructure investments to determine which is the most efficient. The Excel tool solver was used to obtain optimal portfolios. The author maximizes the Roy’s safety-first ratio: a risk-adjusted return performance metric measuring the risk that the portfolio value will fall below a minimum acceptable level over a time period. The author considers various levels of risk aversion as minimum return requirements. The diversified portfolio appears to be the most efficient for all types of investors. However, during a financial crisis, the portfolio made up of infrastructure investments is the least affected and the most efficient. The analysis demonstrates that infrastructure investments are less affected by specific economic situations than are other types of assets, although a diversified portfolio is more efficient in normal times.

TOPICS: Private equity, other real assets, portfolio construction, statistical methods

Key Findings

• • Infrastructure deals differ from traditional assets; they are long term investments providing stable cash flows with a low volatility.

• • This article measures the risk-adjusted return of a portfolio using the Roy’s safety-first ratio allowing us to determine the best allocation of capital to maximize it.

• • Infrastructure investments do diversify portfolios by reducing it is volatility to external events, such as a financial crisis.