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Once the principle markets most relevant to measurement of the broad unlisted infrastructure market are knownthe 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 regulationguidance. 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 unobservable 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 information available 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].
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- 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.
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Index Universe Inclusion Criteria: Individual Constituents
To be included in a broad market index as defined earlierthe Index Universe, unlisted infrastructure investments in countries that meet the minimum market inclusion criteria defined in section [principal]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 valuation IFRS guidance and relevant scientific principles discussed in the next section and that can be expected to capture fair value within a reasonable margin of error.
These critera includecriteria 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.
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