Why Infrastructure Investors Are Losing Their Appetites

Appetite for new infrastructure allocations is falling among institutional investors as the challenges facing the sector have increased, according to a survey by BlackRock.

The asset manager quizzed 248 senior staff from insurance companies, managing $6.5 trillion, and found that more than a third were planning to decrease their exposure to infrastructure debt. A quarter of respondents said they would be reducing their allocations to infrastructure equity.

“Many insurers who had planned increases to their portfolio are revising their goals for this asset class and are seeking to diversify elsewhere.”BlackRock’s report into the survey results said infrastructure was “highly competitive, in short supply, and sometimes has lower than expected yields.”

“As a result, many insurers who had planned increases to their portfolio are revising their goals for this asset class and are seeking to diversify elsewhere,” the report added.

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Patrick Liedtke, head of financial institutions at BlackRock, said supply dynamics had also changed during 2015. Banks “have not pulled back as much as expected” from infrastructure, he said, as regulatory pressure has eased. In addition, banks have noticed the rising demand for assets and so are more willing to hold on in an effort to get a higher price.

“A lot of companies have opened up to infrastructure but have had a reality check,” Liedtke added. “Opportunities aren’t as good as they were so investors are taking a step back.”

A recent report from data company Preqin said that infrastructure funds closed in the first nine months of 2015 had taken on average more than two years to achieve their fundraising target. The 160 funds in the market seeking investor capital at the start of October was the highest number on record, Preqin said, while uncalled capital across all funds stood at $115 billion.

Andrew Moylan, head of real assets at Preqin, said infrastructure fund managers were “facing more competition to put capital to work, and finding attractive assets at compelling pricing is a challenging prospect.”

A performance study by Cambridge Associates suggests diversified growth fund manager selection is “critical” as few products do what they say they will.

Diversified growth funds (DGFs) are expected to reach £200 billion ($307 billion) in three years’ time—but the products are failing to deliver what they promise, according to Cambridge Associates.

The consultancy firm found the average return from DGFs lagged behind that of a “simple, old style balanced fund” in the period since it launched its first index of the funds in 2007.

“Even a moderate return differential between DGF managers can be impactful in the low absolute return environment.” —Alex Koriath, Cambridge Associates“In our view, the DGF’s aim to generate long-term growth with lower volatility than equities, while intuitively appealing for pension funds, is inherently difficult to achieve,” said Alex Koriath, head of the UK pension practice at Cambridge Associates.

The company’s study—involving 35 DGFs with at least £30 million in assets—found that the median DGF manager’s return was 3.3 percentage points below that of a traditional “balanced” fund, split 60:40 between equities and bonds. DGFs are typically invested across a wider range of asset classes.

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“In our view, the DGFs aim to generate long-term growth with lower volatility than equities, while intuitively appealing for pension funds, is inherently difficult to achieve,” Koriath said.

In addition, the difference between the best and worst performing DGFs was 1.1 percentage points a year over the period measured. In the 12 months to March 2015, the latest data point in the study, the top 25% of funds outperformed the bottom 25% by 26 percentage points, making manager selection “critical”.

“Even a moderate return differential between DGF managers can be impactful in the low absolute return environment that [pensions] face today,” Koriath said. “But these are really quite enormous differences in performance.”

On top of this performance data, Cambridge Associates claimed its research showed many DGFs “were not constructed in a way that would deliver inflation-plus returns”, despite such products often targeting returns in excess of inflation.

“In most cases, we believe these targets to be aspirational at best,” the group said in a press release announcing the research.

Koriath said most DGFs did not demonstrate a significant proportion of inflation-linked assets, suggesting the managers were not explicitly targeting inflation. Cambridge’s research showed the median DGF “was highly correlated to a 60:40 mix of equities and bonds mix but exhibited little or no link to inflation”.

Cambridge highlighted that “absolute return” DGFs, which have the ability to use derivatives and take short positions, have performed in line with traditional DGFs but with “less equity upside and downside”.

The findings were detailed in a report, “Navigating the Diversified Growth Fund Maze”, written by Alex Koriath, Himanshu Chaturvedi, and Max Gelb.