In this blog I’ll be taking a look at the area of infrastructure and private assets and how you can make the most of this great opportunity by making sure you have the right preparation, pricing strategy and risk modelling in place. In the current climate of low interest rates and ongoing scepticism around fully committing to the equity market, investors are typically looking for alternatives – with private assets usually firmly on their list. This move has, however, brought a new challenge around how to model the potential returns and price movements, as well as how to get investors to embrace an illiquid idea that forces them to consider their longer term approach. I’ll take a look at the effects of this demand and the challenges that have come for the advisory industry in clients wanting to understand more about this potential opportunity.

The changing situation

With the economic outlook still leading investors to shy away from significant equity exposure and low interest rates making investors sceptical about the fixed income market, there is an increasing demand for products that are not entirely linked to global markets – which is where more illiquid assets suddenly become a greater attraction.

Much like individuals seeing their own home as their future security, a growing number of big investors are considering the idea of investments that are more tangible and guaranteed in a world of financial uncertainty – which has seen infrastructure and the idea of the security of bricks and mortar becoming increasingly in demand. In Canada it has become not uncommon for schemes to have an allocation of up to 50% in these types of assets and, although there is currently a lower trend in Europe (up to around 20%), the demand for research and advice is growing there too.

For investors who can afford to take a much longer term consideration for their money, such as large pension funds, private and illiquid assets can be a great source of diversification and revenue generation. The effect of this increased demand from investors has been the need for their advisors to take the lead, not only in providing a strong enough way of modelling the potential of the investments and the liquidity challenges these investments bring, but also in many cases to help change the mind-set and targets of investors who had previously remained quite short-term and reactionary in their strategy.

Meeting the challenges

The modelling aspect, particularly with infrastructure, is where advisors need to do their work. It is not enough to simply model against set benchmarks or indices for real estate, as they often don’t reflect direct private investment models well enough. So a pricing structure and strategy just using basic market and national GDP correlations for example, is not always compelling enough for investors to agree to.

Cash flows and expected returns can be a good approach, but you will also need to be able to come up with a good stochastic valuation method to address any uncertainty around these returns. The challenge is therefore to build a case of consistent and accurate modelling that gives investors the confidence to take the leap. Most investors will acknowledge that infrastructure and other private assets could present them with a really good opportunity both for returns and diversification – providing the investment team can create a truly accurate and useful pricing basis for them.

To meet the investors’ need for clarity of information, advisors should be able to support the case through the results of a range of innovative economic scenario possibilities and a consistent picture for the future about how to assess the viability of these investments. This can be done by using a cash flow approach combined with a stochastic valuation model linking to relevant economic drivers.

How to get it right

The wider availability of good quality modelling in the industry is currently in need of more attention. It is an area that we are regularly asked to provide our dynamic real world scenarios. These scenarios should reflect dynamics that can be seen in economic and financial markets in both the short term and the long term behaviour. We are then able to help model a strategy that refines the direction of the investment plan and helps avoid unnecessary risks and unknowns that can put off some less confident investors.

It is then important to work with clients’ investment teams to match their pricing structures with the scenario models to not only ensure consistency in the approach, but also to build a wider strategy outlook for performance measurement and future pricing.

In summary

For something so tangible there are certainly still plenty of variables and uncertainties around how to approach infrastructure and private asset investing. This should not be a deterrent however, but rather an encouragement to make sure you do it really well - to complement your pricing models with scenario generation and identifying the parameters you can work with that will allow you to make the most of a great market to be in for the long term.


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