Significance of infrastructure investments in emerging markets to institutional investors.
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Date
2020
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Abstract
The worldwide financial crisis of 2007/8 and the subsequent economic slump led to significant funding and solvency challenges for institutional investors as their financial positions were adversely affected. The former institutional investors’ investment ‘safe haven’, being real property/estate, was one of the catalysts for the 2007/8 crisis as the real estate market experienced substantial losses. These experiences altered institutional investors’ perceptions towards their traditional asset and portfolio allocation strategies. In an attempt to avoid poor returns and excessive volatility from real estate, bonds and money market instruments, institutional investors are now in a new drive to diversify and supplement their core assets. As a result, institutional (and individual) investors are on the hunt for better yields, diversified portfolios, and inflation hedged returns so that they can meet their long term inflation-indexed liabilities and remain afloat.
Infrastructure sector investments, given their theoretical narratives and attractive investment characteristics qualify to be the new investment niche and appropriate for long term institutional investors. This claim to the attractiveness of infrastructure investments can be rejected or shelved if empirical analysis of infrastructure investment features yields contrary results as the attractive risk-return profile of infrastructure investments might be ‘illusory’. The illusion is amplified by the differences in infrastructure investments in developing and developed markets. This thesis evaluated the economic or financial intrinsic infrastructure investment features to ascertain if institutional investors (in their hunt for new investment avenues), can derive value from the same in emerging markets where the infrastructure gap is high and the infrastructure market still developing. Academic studies on infrastructure investments in emerging and developed markets are scant. The few available academic studies applied very basic statistical measures on the subject matter. The present study adopted, portfolio optimization approach, risk-adjusted return measures, linear and non-linear autoregressive distributed lag (ARDL) models, panel ARDL as well as EGARCH and GJR-GARCH models to achieve the set objectives. As such, the study makes notable contributions to the body of knowledge by applying appropriate econometric models using emerging nations as a case. The results indicated that unlisted or private infrastructure securities can amplify portfolio returns and dampen portfolio risk. The significance of infrastructure investment to institutional investors is thus limited to enhancing portfolio returns and reducing portfolio risk. The results showed that listed or exchange traded infrastructure’s risk-return profile is similar to that of real property and general emerging equity market returns in emerging markets. Private and listed infrastructure exhibited different stochastic and distributional features implying that they can play a complementary role in a portfolio. This implies that investors can hold listed and private infrastructure in the same portfolio without sacrificing portfolio performance.
Listed infrastructure exhibited remote inflation hedging ability on short term basis. All other assets are poor inflation hedges in emerging markets implying that investors must consider other assets which can hedge inflation risk. All the assets under consideration exhibited significant volatility clustering, volatility persistence and leverage effects. GJR-GARCH specification under GED proved to be the optimal volatility model for all assets under study. This implies that corporates in the infrastructure sector (as well as real property and general equity) in developing economies should be prepared to absorb an additional risk premium as lenders are exposed to significant volatility persistence. On the same note, investors should also come up with other sources of liquidity as volatility persistence will increase the cost of providing liquidity in emerging markets. Investors are recommended to allocate a significant part of their capital to unlisted infrastructure so that they can enhance their portfolio performance and reduce portfolio diversifiable risk. In order to hedge inflation risk, investors are recommended to look beyond infrastructure, real property and the general equity market in emerging markets. Policy makers in emerging companies are recommended to design contracts and concessions which link returns from long term infrastructure returns to inflation rate. On the same note, regulators in emerging financial markets are recommended to come up with policies which dampen the volatility of asset prices which in turn restore investor confidence, thereby attracting long term capital. Investors are encouraged to consider leverage effects when computing their value-at-risk figures and when making investing decisions. Researchers are encouraged to unbundle the infrastructure sector, and emerging markets ‘groups’ when making future studies. On the same note, as data become available and the economic environment changes, inflation hedging capabilities of the assets covered in this study can be evaluated on a longer term basis in different inflation environments.
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Doctoral Degree. University of KwaZulu-Natal, Durban.