Inflation hedging and protection characteristics of infrastructure and real estate assets
| Date | 02 February 2015 |
| DOI | https://doi.org/10.1108/JPIF-04-2014-0026 |
| Published date | 02 February 2015 |
| Pages | 19-44 |
| Author | Daniel Wurstbauer,Wolfgang Schäfers |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
Inflation hedging and protection
characteristics of infrastructure
and real estate assets
Daniel Wurstbauer and Wolfgang Schäfers
International Real Estate Business School, University of Regensburg,
Regensburg, Germany
Abstract
Purpose –Similar to real estate, infrastructure investments are regarded as providing a good
inflation hedge and inflation protection. However, the empirical literature on infrastructure
and inflation is scarce. Therefore, the purpose of this paper is to investigate the short- and long-term
inflation-hedging characteristics, as well as the inflation protection associated with infrastructure and
real estate assets.
Design/methodology/approach –Based on a unique data set for direct infrastructure performance,
a listed infrastructure index, common direct and listed real estate indices, the authors test for short- and
long-term inflation-hedging characteristics of these assets in the USA from 1991-2013. The authors
employ the traditional Fama and Schwert (1977) framework, as well as Engle and Granger (1987)
co-integration tests. Granger causality tests are further conducted, so as to gain insight into the short-
run dynamics. Finally, shortfall risk measures are applied to investigate the inflation protection
characteristics of the different assets over increasingly long investment horizons.
Findings –The empirical results indicate that in the short run, only direct infrastructure provides
a partial hedge against inflation. However, co-integration tests suggest that all series have a long-run
co-movement with inflation, implying a long-term hedge. The causality tests reveal reverse
unidirectional causality –while real estate asset returns are Granger-caused by inflation, infrastructure
asset returns seem to cause inflation. These findings further confirm that both assets represent a
distinct asset class. Ultimately, direct infrastructure investments exhibit the most desirable inflation
protection characteristics among the set of assets.
Research limitations/implications –This study only presents results based on a composite direct
infrastructure index, as no sub-indices for sub-sectors are available yet.
Practical implications –Investors seeking assets that are sensitive to inflation and mitigate
inflation risk should consider direct infrastructure investments in their asset allocation strategy.
Originality/value –This is the first study to examine the ability of direct infrastructure to assess
inflation risk.
Keywords Real estate, Co-integration, Inflation hedge, Inflation protection,
Infrastructure investments, Shortfall risk
Paper type Research paper
1. Introduction
Inflation has long been identified as a major risk for individual investors, especially for
those who aim to match their real liabilities through the investment process. Although
inflation rates have been relatively low in the past few decades, the influence of
inflation on invested capital needs to be addressed by investors with a long-te rm
investment horizon. In addition, inflation may well be on the rise over the next few
years, due to the generally loose money policy in the aftermath of the financial crisis.
Therefore, inflation is certainly back on the agenda and investors seek opportun ities
with inflation-hedging characteristics to add to their mixed-assed portfolios in order to
counter inflation risk.
Journal of Property Investment &
Finance
Vol. 33 No. 1, 2015
pp. 19-44
©Emerald Group Publis hing Limited
1463-578X
DOI 10.1108/JPIF-04-2014-0026
Received 29 April 2014
Revised 14 July 2014
Accepted 14 July 2014
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1463-578X.htm
19
Infrastructure
and real
estate assets
Real estate investments have traditionally been perceived as a good inflation hedge
and constitute a decisive share of institutional investors’portfolios. This is attributable
mainly to the fact that the nominal cash flows of real estate assets are either
contractually linked to inflation or can be renegotiated from time to time. As a
consequence, investors are able to adjust the cash flows in line with the changes in the
price level. More recently, there has been a growing interest in alternative asset classes,
such as infrastructure, and investors seek to expand their allocation of such assets
within their portfolio (Mercer, 2012; Dechant et al., 2010). Investors thereby perceive
infrastructure rather as a complement than as a substitute for real estate. Studies
suggest that most of the institutional investors already place infrastructure in a specific
infrastructure allocation and only very few place it with real estate. Besides that,
infrastructure is also sometimes categorized as “inflation-hedged”or a “real asset”
(Probitas Partners, 2011). The significance of a separate allocation is affirmed by recent
asset allocation studies which show that listed infrastructure (Oyedele et al., 2014) as
well as direct infrastructure (Dechant and Finkenzeller, 2013) are not a substitute
for real estate within the mixed-asset portfolio and therefore should be included. Both
studies conclude that infrastructure helps to reduce the portfolio risk rather than to
increase overall portfolio performance.
In general, infrastructure investments can be divided into two main categories:
economic and social. Whereas economic infrastructure investments comprise assets
in the transportation, energy, water, gas and comm unications sectors, social
infrastructure investments typically compromise assets in the healthcare or
education sectors (Wagenvoort et al., 2010; Weber and Alfen, 2010)[1]. Hence, real
estate and infrastructure share some technical characteristics, such as indivisibil ity and
tangibility. Similar to real estate, the cash flows generated by infrastructure assets
are often contractually or regulatorily linked to inflation. Moreover, infrastructure
assets are regarded as resilient to inflation on account of their specific characteristics, such
as high replacement costs, high pricing power and a low share of operating costs after
initial construction (Croce, 2011). Consequently, infrastructure investments may constitute
a further desirable investment alternative for institutional investors as a means of
accounting for inflation. This argument is backed by recent surveys among institutional
investors, which reveal that the desire to invest in assets with inflation-hedging
characteristics is one of the most important drivers of infrastructureinvestments (Probitas
Partners, 2013).
While there is already a broad body of literature on the linkage between real estate
and inflation, there are only few studies examining the inflation-hedging characteristics
of infrastructure investments. Moreover, the empirical findings so far are limited to
listed infrastructure investments due to the absence of reliable and accessible
performance data for direct investments. Interestingly, the findings so far suggest that
listed infrastructure is not a good hedge against inflation which contradicts the general
belief and expectations of investors. However, the primary route for investors to gain
exposure to infrastructure is via unlisted funds or direct investments (Preqin, 2014) and
no empirical evidence is available that might help investors to evaluate their
expectations. Therefore, the main objective of this paper is to fill the empirical gap on
(direct) infrastructure investments and its relationship to inflation in order to help
investors to better understand the asset class towards its inflation-hedging ability.
By means of a unique data set of US direct infrastructure performance, which was first
used by Dechant and Finkenzeller (2013), we are able to employ commonly
used methods from the finance and real estate literature in order to examine the
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JPIF
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