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Shifting the paradigm: Three routes to maximizing infrastructure finance for development | Job Oriented Course in Talegaon, Pune | Top Construction Management Colleges in Talegaon, Pune

Shifting the paradigm: Three routes to maximizing infrastructure finance for development | Job Oriented Course in Talegaon, Pune | Top Construction Management Colleges in Talegaon, Pune

By promoting better standards, methods and benchmarking, development finance institutions can move the mountain that is preventing institutional capital from flowing into infrastructure.
The World Bank Group's initiative to aims to find solutions to crowd in all possible sources of finance, innovation, and expertise in order to achieve the Sustainable Development Goals (SDGs). In the case of infrastructure investment, a significant contribution to long-term sources of private finance is expected from institutional investors such as pension plans, life insurers, and sovereign wealth funds.
These investors have become increasingly interested in infrastructure investment in recent years, in search of new sources of returns, diversification, duration and inflation hedging. However, they cannot be expected to make a substantial and durable contribution to the long-term financing of infrastructure without three important changes:

1. Valuation methodologies need to improve to represent financial performance more accurately. 
Current valuation methodologies used in private infrastructure are wrong.Fifty percent of respondents of the largest survey of asset owners ever undertak. Discounting 25 years of “base case” cash flows using a single discount rate built from ad hoc risk premia assumptions, with little regard for the term structure of risk that characterizes infrastructure firms, contradicts basic corporate finance textbooks. It is easy to do a lot better.
Advanced private asset pricing techniques using stochastic Discounted Cash Flow modeling that takes into account market transactions and systematic sources of risk can make significant improvements to current valuation methodologies. Today’s approach, based on “forward-looking views,” often amounts to unrealistic guesswork about the future of energy prices or the world economy over the next 25 years.

2. Credit risk methodologies need to evolve to better capture default risk.
Infrastructure debt seldom defaults. Even if a large number of credit instruments is observable, a representative set of default events may not be at hand, especially if no attempt is made to control for financial structure or business model. If almost no defaults have been reported in project finance 10 years after origination, is 10-year old project debt risk-free? Is it AAA-rated? Of course not. The so-called "reduced form" models used by credit rating agencies work well when large samples of defaults can be observed. When this is not possible, structural models that look at the risk of crossing certain observable default thresholds (like the debt service cover ratio) perform a lot better.
Recent EDHECinfra results show that such an approach accurately predicted default rates as high as 5 percent in European merchant infrastructure in 2013, or a cumulative 10-year default rate close to 50 percent in Spanish infrastructure projects. A far cry from the usual “stylized facts” from credit risk studies but also much more realistic in hindsight. Importantly however, this approach would also have predicted this level of credit risk at the time

3. Proper benchmarks capturing risk should be used to evaluate infrastructure investment.
Infrastructure is often described as an absolute return strategy. It is expected to deliver a certain level of performance defined ex ante, typically a few hundred basis points above the risk-free rate or inflation.While such return targets can be useful for investors, especially if they have liabilities defined in similar terms, the performance of infrastructure products, strategies, and teams should not be compared with "absolute" returns. Benchmarking a strategy against "risk-free-plus-five" implies that it is risk-free and has an alpha of 5 percent! Instead, infrastructure investors are exposed to credit risk, interest rate risk, macro risks, and certain systematic risks only found in infrastructure (e.g., the systematic differences between merchant, contracted, and regulated investments). They are also likely to be exposed to risk factors found in stocks such as the size (small outperforms large) and momentum (winners tend to keep winning) effects.
Only by insisting on adequate risk-adjusted benchmarks can investors' disillusionment with performance measurement in private infrastructure investment be counteracted. This, in turn, requires better methods, data, and reporting to better understand and measure risk and performansion.

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Institute of Infrastructure Studies and Construction Management (IISCM) has been established under the aegis of AUREOLE Education Foundation, an autonomous, non-government, non-profit academic organization.

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