A new study by EDHECinfra (EDHEC’s infrastructure institute based in Singapore), has a striking point of view on the whole “listed infrastructure” sector, which it says is based on the “fallacy of composition.”
In economics and in logic, the term “fallacy of composition” refers to the general prejudice that if X is true of A, and B, and C, and something else (Z) is composed of A, and B, and C, then X must be true of Z. It ain’t necessarily so.
A common counter example runs this way. It may well be true that if John, watching a baseball game in the bleachers, stands up, he will get a superior view of the game underway. If may also be true that if Mary stands up, she likewise will see better. And if Joe stands up, he will see better. When the whole crowd is seated, that proposition may be true of each and every member of the crowd. But it clearly doesn’t follow that if they all stand up, they will all see better.
Why It Is a Fallacy
In that case, John will see the baseball game more clearly if he alone stands up precisely because he will be the exception in a generally seated crowd. When he is no longer the exception, when everyone is standing, then there is no advantage to standing. Thus, inferences from the parts to the whole are unavailing.
In finance, a close analogy to the ballpark example suggests itself. There might be many strategies that work for a first mover, but that are quickly exhausted. Once exhausted, they yield no benefit either to the first mover or anyone else.
This brings us back to the EDHEC study. Infrastructure investment has long been “the preserve of large sophisticated investors,” EDHEC contends, “but is now rapidly becoming more mainstream and asset owners of all sizes are considering investing in infrastructure.” There are lots of people standing up to watch the game. Further, the notion that infrastructure is a superior investment, insofar as it rests on anything at all, rests on an institutional memory of those earlier times, and on … the composition fallacy.
EDHECinfra tested 21 different indexes of listed infrastructure stocks. They found that they are all highly correlated with the relevant market index, with either equivalent or greater risk than the broader market.
No Discernable Effect
By adding one (any!) of those indexes to a portfolio, an investor achieves … nothing. No “discernable effect on their mean-variance efficient frontier” back testing for the last 15 years.
Private infrastructure entities do in fact, the study acknowledges, have unique characteristics: but they are not by definition available through the stock market.
The study was prepared by Frederic Blanc-Brude, Tim Whittaker, and Simon Wilde.
The Intuitive Narrative
Investors are beguiled, these authors posit, by an intuitively appealing but false narrative, one that posits:
• That an infrastructure asset class exists, which is distinct from other industrial holdings because of the low price-elasticity of infrastructure services;
• That the value of investment in this class is mostly determined by income streams that promise to extend into the distant future, beyond any particular business cycle; and that consequently
• This value exhibits low return covariance with other financial assets.
Index providers have played upon this intuition, as have “a number of active managers” who propose to invest in the hypothetical asset class, listed infrastructure.
There are three ways in which one might define listed infrastructure for the purpose of testing that narrative and such claims. One might simply create a rule based filtering of stocks based on industrial sector classifications, one might stick to the indexes defined and maintained under this head by the index providers, or one might create a basket of stocks working not from industrial sector but from the centrality of long-term public-private contracts.
The first and second of these prove to be of no use, the authors say. The third proves to be of some use, but not in the way the tellers of the beguiling narrative supposes.
On The Source
EDHECinfra was started in February 2016 by the EDHEC Business School. It exists in order to address the issues faced by infrastructure investors, and it currently has a team of 10 full time researchers.