Risk-adjusted returns of infrastructure debt are significantly better than infrastructure equity and leveraged loans Summer 2016
Summer 201613 May 2016
The Sharpe Ratio of Sequoia Economic Infrastructure Income Fund (SEQI) is calculated to be 0.82 vs infrastructure equity at 0.35 and leveraged loans at 0.16.(1) This shows 2.3x as much return per unit of risk as equity and 5.1x as much as leveraged loans. This is largely due to lower return variability of infrastructure debt vs infrastructure equity and lower returns for leveraged loans.
Summary: economic infrastructure debt has high returns per unit of risk
- SEQI delivered over 2.3x as much return per unit of risk as did infrastructure equity during the study period.
- Risk-adjusted returns of economic infrastructure debt are significantly better than other asset classes such as infrastructure equity largely due to similar returns to equity but with much less return variability. This comparison uses a 1/3-2/3 mix of mezzanine economic infrastructure debt and senior economic infrastructure debt, respectively.
- The lower return variability of infrastructure debt vs infrastructure equity is due to debt’s more steady cash flows and very low loss rates.
- The Sharpe Ratio for leveraged loans is much lower than infrastructure debt due to lower returns for leveraged loans.
Analysis: SEQI Sharpe Ratio consistent with Dow Jones infrastructure index
Shown above is the Sharpe Ratio for SEQI. Also shown are the Sharpe Ratios for infrastructure equity and leveraged loans, represented by the S&P Global Infrastructure Index and the S&P/LSTA Leveraged Loan Index, respectively.(2) During the study period, SEQI’s portfolio consisted of approximately 1/3 mezzanine economic infrastructure and 2/3 senior economic infrastructure.
As an additional reference, the annualized Sharpe Ratio for the Dow Jones Brookfield Global Infrastructure Broad Market Corporate Bond Index (DCR) was 0.70 for the 3-year period from 2013 to 2015.(3) This acts as a good confirmation of SEQI’s 0.82 Sharpe Ratio. The DCR index consists of high yield and investment grade corporate debt issued by infrastructure companies globally.
The Sharpe Ratios are calculated by dividing the annualized excess returns by their respective standard deviations. Excess returns are calculated as the actual realized returns less the appropriate risk free rate.
Other asset classes: economic infrastructure debt Sharpe Ratio higher than other major asset classes
By comparison, other asset class Sharpe Ratios are presented below.(4) Infrastructure debt has a better risk-return profile than infrastructure equity, leveraged loans and these other four asset classes because it is an underinvested asset class. Banks have been lending to infrastructure projects for years but investment managers have not been looking for investment opportunities. This is why infrastructure debt has a superior risk-return profile and a positive alpha (see "Equity betas for listed infrastructure funds," October 2015).
(1) Originally called the reward-to-variability ratio in Willian F. Sharpe, "Mutual Fund Performance," Journal of Business, January 1966. It shows the amount of return per unit of risk, where risk is the standard deviation of the return.
(2) The S&P Global Infrastructure Index includes 75 global companies that represent the listed infrastructure equity universe. It includes the utility, transportation and energy sectors.
(3) S&P Dow Jones Indices, McGraw Hill Financial, February 2016.
(4) Thomson Datastream, 25-yr period January 1989 to January 2014. Global equities represented by the MSCI World Index (total return), global corporate bonds by BofA Merrill Lynch Global Broad Market Index (total return) and commodities by the S&P GSCI commodity index (total return). Global corporate bonds from 1996, when the index was created.