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Deserving of Allocation
How does this all play out in real life? As a simple backtest, we created two standard asset allocation portfolios, one including a 10 percent allocation to Infrastructure and one without. For the non-infrasture portfolio, we apply an equal 5 percent allocation to both fixed income and U.S. equity (Figure 13).
We then examined the performance of these portfolios over the past five years. Over that stretch, the inclusion of infrastructure improved certain aspects of the portfolio's performance, most notably the absolute and risk-adjusted returns. It is, however, important to note that the inclusion of increased amounts of fixed income in the non-infrastructure portfolio may have contributed to a lower standard deviation for that portfolio. However, over a five-year period, the infrastructure portfolio exhibited a higher Sharpe ratio than the portfolio without infrastructure.
Bear Market Performance
For any diversifying asset, the real question is how it performs when the markets decline. For all our praise of non-correlated assets, the truth is that we want our assets to be correlated when the mar- ket is rising.
Figure 14 examines the performance of the infrastructure sector from July 2000 to December 2002, during which time the domestic equity market suffered a severe downturn. As shown, infrastructure performed markedly different from the broader US equity market over this stretch, handily beating the S&P 500.
It is important to note that the correlation of infrastructure to U.S. equities dropped from its five-year average of 0.6 to just 0.3 during this bear market stretch. That is, when the market fell, infrastructure decoupled from the S&P 500 Index. That is just what you want to see happen.
To Index Or Not To Index?
Individual Security Risk
Deciding how best to add infrastructure exposure to a portfolio is important. Historically, the sector has been dominated by private equity deals. Many investors, however, are not in-tune with the characteristics of individual deals, or have been frightened by the high capital requirements of investing in private equity funds. It turns out that they were frightened for good reason.
Figure 16 reveals an important characteristic of the infrastructure market: single security risk. As shown, investors could have experienced a wide range of outcomes based on attempts to invest in individual infrastructure equities. We imagine that the dispersion of returns for individual private equity deals is higher still.
Country Risk
Similarly, different infrastructure markets have performed differently over time. Figure 17 shows that there has been a widespread dispersion in returns between the best- and worst-performing countries in the Macquarie Global Infrastructure 100 Index.
In light of these challenges, investors interested in tapping the benefits of infrastructure exposure would be wellserved to consider accessing this unique asset class through index-based investments.
Conclusion
With many unique attributes, infrastructure can be though of as a separate asset class that deserves the attention of investors with an appetite for exposure to defensive, high-yielding securities. As this asset class emerges, we expect it may follow a course similar to REITs: one of growth and diversification. Among the key components that could drive this growth are increasing demand from both institutional and retail investors and increasing supply from the growing privatization of infrastructure assets. If exposure to infrastructure is an investment objective, gaining this exposure through an index-based vehicle such as an ETF is likely the most efficient means for the vast majority of investors.
Endnotes
1 Macquarie Research, June 2005 "Macquarie Global Infrastructure 100 Index: New Performance Benchmark.
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