Long-term investment in infrastructure projects in emerging markets outperforms the S&P 500, according to new research from the International Finance Corporation (IFC).
The findings suggest investors may be overestimating risk in these jurisdictions, with IFC stating that the perceived risk-return profile is “more pessimistic than warranted.”
The study adds momentum to calls for banks to be freed from regulatory burdens that they say limit their ability to invest in infrastructure projects in Africa.
Home to some of the world’s fastest-growing economies, the continent suffers from an $85 billion annual infrastructure funding gap, limiting growth and opportunity.
A research report by IFC, the investment arm of the World Bank and the largest global development agency focused on the private sector in developing countries, finds infrastructure financing in emerging markets to be an attractive investment case.
“An uninformed view of the risk and return profile of investing in developing countries may be more pessimistic than justified by the actual performance of investing in emerging markets. Better information and transparency could therefore help,” the research note said.
“If data analysis reveals that actual returns on investments in riskier emerging markets exceed uninformed perceptions, foreign investors may be more inclined to favor investments in these markets.
“If global investors had made private equity investments in emerging market infrastructure alongside IFC, they would have achieved, on average, better returns over the long term than owning the S&P 500, and better returns than the MSCI Emerging Markets Index.”
The study was conducted by University of North Carolina professor Anusha Chari, an economist and financial expert. Peter Blair Henry, Senior Research Fellow, Freeman Spogli Institute, Stanford University; and Paolo Mauro, director of economic and market research at IFC.
By working with global investor IFC to make private equity investments in emerging market infrastructure, we would have achieved, on average, better returns over the long term than owning the S&P 500 and better returns than the MSCI Emerging Markets Index.
— International Finance Corporation survey
We examined the performance of stocks in emerging market infrastructure ventures backed by IFC over the past 60 years and compared these investments to a portfolio of publicly traded stocks.
IFC said this was done using an open market equivalent calculation that takes into account all funds invested in private funds (contributions) and all funds received (distributions).
Specifically, IFC said it discounts these cash flows by their public market equivalents, using the open market returns of an index such as the S&P 500 over the same period as the discount rate.
Business Day reported earlier this year that the B20 South African Financial and Infrastructure Task Force made a major push to ease Basel III capital requirements, with the aim of giving banks more room to invest in infrastructure projects to reignite Africa’s economy and integration.
Standard Bank Group CEO Sim Tshabalala, who chaired the task force, said in an interview with Bethan Charnley, principal at international management consulting firm Oliver Wyman, that there was an argument that the risk-weighted assets and capital held by banks under Basel standards needed to change to match the “real risks” associated with project risk.
He said this would lead to increased lending by banks to finance much-needed infrastructure on the continent, and that the outlook was closely linked to that of South Africa’s major banks.
“Globally, there is a strong view that there is enough regulation and that the regulators are putting down their pens.
“There is also another view that we have had to try to reconcile, and that is that global microprudential regulation is being drafted in a way that addresses a set of problems that did not exist in emerging markets, particularly Africa.
“And one of the sets of regulations relates to the capital required for projects and indeed the capital required for banks to take on multilateral financial institutions and development financial institutions, so that we have more capital for these projects and these institutions commensurate with the risk.”
The Bank of England last week cut the amount of capital it estimates lenders need to hold to boost lending and stimulate the economy, the first such move since the 2008 global financial crisis.
