- Observable market inputs are the most relevant type of data to assess the fair value in private investments. Their use should be maximised in the valuation process.
- For infrastructure, only indirect market prices and/or proxies are available to assess fair value on an ongoing basis.
- Minimum data availability about individual investments, including audited accounts, is part of the inclusion criteria of individual assets in the infrastructure universe.
Once the principle markets most relevant to the index Universe are identified, a number of pricing or input data may be used in the valuation process.
The inputs of the valuation process are given significant emphasis in the fair value guidance. Under IFRS 13, valuation inputs are categorised according to a 3-level hierarchy depending on how observable they are, especially whether actual transaction prices can be observed, directly or not.
The highest credibility (level-1) is given to (unadjusted) quoted prices in ‘active’ markets (with frequent trading of individual financial assets) for identical assets or liabilities that buyers and sellers could access at the measurement date [IFRS 13:76].
Level-1 valuations inputs are mostly unavailable for individual unlisted infrastructure debt and equity investments. However active their reference market may be, taken individually unlisted infrastructure assets or liabilities are not frequently traded. They are by nature highly illiquid and only change hands a few times in their lifetime (once on average), if at all.
Nevertheless, since level-1 inputs would provide the most reliable evidence of fair value, as defined under IFRS 13, they remain the point of reference to measure the value of unlisted infrastructure investments. In other words, the valuation models used to measure the performance of unlisted infrastructure investments must aim to emulate market mechanisms and to produce valuation estimates as if these assets were quoted in active markets on the measurement date.
Level-2 inputs are either directly or indirectly observable prices that are not quoted in active markets [IFRS 13:81]. This includes:
- Public proxies: quoted prices for similar assets or liabilities in active markets i.e. to the extent that similar investments exist in public markets, the value of unlisted infrastructure investments may be proxied using public market data;
- Private proxies: quoted prices for identical or similar assets or liabilities in markets that are not active i.e. to the extent that they are comparable, the transaction prices reported by the buyers and sellers of private infrastructure assets may be used to estimate the value of unlisted infrastructure investments that were not traded on the measurement date;
- Market inputs: inputs other than quoted prices that are observable at commonly quoted intervals, such as interest rates and yield curves.
Level-3 valuation inputs are not observable market inputs [IFRS 13:86] and are used to measure fair value to the extent that relevant observable price inputs are not available because there is little or no relevant market activity on the measurement date. This requires using the best available information including audited accounts, private owner data and models, taking into account all information about market participant assumptions that are reasonably available [IFRS 13:87-89].
Unlisted Infrastructure Valuation Inputs
In the case of unlisted infrastructure investments, relevant and observable inputs in the valuation of unlisted infrastructure investments are defined as follows:
As discussed above, Level-1 inputs can be considered unavailable in the overwhelming majority of cases.
Level-2 available inputs include:
- Actual transaction prices: primary and secondary transaction prices can be observed as and when unlisted infrastructure investments are made, reflecting the ‘revealed preferences’ of market participants at that point in time;
- Unlisted equity prices include primary investments amounts in newly created or freshly privatised infrastructure companies and secondary market transactions, when they occur;
- Private debt instrument prices include primary origination amounts and credit spreads, as well as secondary market sales when they occur.
- Public market proxies: a direct equivalent of the unlisted infrastructure sector is difficult to find in public markets (see ) but the market price of certain subgroups of unlisted infrastructure investments may be observable in public markets and used to estimate risk factor prices for unlisted infrastructure investments. They include listed infrastructure vehicles that solely hold the equity or debt of unlisted infrastructure projects that meet the TICCS® definition of infrastructure companies, or the listed equity or debt of specific listed companies that also meet theTICCS® definition. Still, even if the assets are comparable, the markets in which these firm trade are unlikely to be a reflection of the principal market for unlisted infrastructure because the nature of the buyers and sellers expressing their preferences in public market is considerably more diverse and heterogeneous than that of investors in unlisted infrastructure. The average price preferences of the former may not be represent those of the latter very well;
- Contingent transaction prices: a case of market-corroborated price data for illiquid and seldom traded assets is the use of so-called contingent valuation techniques i.e. surveying investors to establish their ‘stated preferences’ with regard to certain types of private assets. A first example of such a survey was conducted by EDHECinfra to derive, based on various investment scenarios, the upper and lower bounds on investors’ required expected rate of return in various standardised types of unlisted infrastructure equity and debt investments ;
- Market-based model inputs: As indicated above, in the context of discounted cash flow (income-based) valuation methodologies, the relevant and current levels of interest, swap and foreign exchange rates can be used when valuing unlisted infrastructure investments in order to better reflect market conditions at the time of measurement.
Finally, there are two types of Level-3 inputs available to value unlisted infrastructure investments:
- Audited financial statements and valuation reports have been validated by regulated and independent auditors and include both historical and forward-looking information:
- Historical information includes realised values for revenues, costs and investments, the evolution of the financial structure, realised profits and losses, etc.
- Forward looking information is captured in valuation reports and accounting values on the asset side of the balance sheet, especially if they are audited under IFRS 13, which would be the case in most OECD jurisdiction. Such assets may be held at cost or fair value (whichever is lower) but fair value is required when assets are impaired, which is critical part of the forward looking information provided by audited accounts.
- Unaudited cash flow forecasts aim to represent the future income, costs and investments made by infrastructure companies. They include:
- Base case forecasts representing the working scenario under which the initial investment decision was made, and may be updated by equity and debt investors at regular intervals;
- Stochastic forecasts using more or less advanced statistical modelling techniques to estimate the expected value and conditional variance of future cash flows. e.g. EDHECinfra uses Bayesian filtering techniques to predict the trajectory of certain cash flow items for individual debt and equity investments as described here.
Index Universe Inclusion Criteria: Individual Constituents
To be included in the Index Universe, unlisted infrastructure investments in countries that are principal markets, must themselves meet a number of constituent-level inclusion criteria. These criteria reflect the possibility of applying a valuation methodology that is in line with the IFRS guidance and relevant scientific principles and that can be expected to capture fair value within a reasonable margin of error.
These criteria include:
- Minimum available data: unlisted infrastructure investment may only be included in the process used to evaluate index constituents if a minimum combination of information is available, including:
- Name, start date and TICCS® classifications of the investment
- Minimum amount of level-2 input data
- Minimum amount of Level-3 input data
- Minimum age: The robustness of the forecasts is greatly improved if a minimum amount of historical data is available for each company, whether equity or debt instruments are being evaluated. Early years performance can only be estimated ex post facto.
The criteria used by EDHECinfra to include individual constituents in its broad market index are detailed in the Universe Standard.