This quarterly valuation update, recorded in early 2022, covers debt and equity trends in energy and infrastructure, then compares the theoretical and market approaches to discount rates.
Debt and equity trends
At the end of 2021, competing trends were driving debt: growth concerns from the Omicron variant on one side, rising inflation and interest rates in some countries on the other. Government and investment grade debt were broadly flat over the quarter, and early 2022 showed rates rising across the board. These trends feed the risk-free rate and the cost of debt used in valuations.
For equity, the panel tracks our own indices of listed infrastructure funds and listed renewable energy funds. Sentiment towards infrastructure equity was positive in the last quarter of 2021, supported by a wave of new listed funds, while renewable energy funds eased slightly despite rising power prices.
CAPM against transaction discount rates
The capital asset pricing model (CAPM) adds an equity market risk premium, adjusted for the volatility of comparable companies, to the risk-free rate. Over the period reviewed, the discount rates CAPM implied for listed infrastructure funds were rising, while the weighted average discount rates those same funds published were falling.
The panel sets out why. Funds set their targets from the fundraising environment and can look past short-term movements in the theoretical cost of capital. Competition for a limited number of assets, helped by their ESG appeal, pushes transaction discount rates down. Lenders tend to adjust their margins as interest rates move, which keeps the cost of debt relatively flat.
Our view
Price is not the same as fair value, but relying on CAPM alone can mislead in infrastructure and energy. Where transactions involve similar assets with a similar risk profile, the discount rates they reveal are the better guide, with transaction multiples as a cross-check. A headline discount rate also means little on its own: it has to be read together with the assumptions in the model. A low discount rate with cautious assumptions can give a lower value than a higher rate with bullish ones.
Questions from the audience
The session closes with questions on expected returns for energy investments in Africa, where country risk premiums can bridge a lack of local benchmarks; which CAPM parameter is most prone to error; and how construction and development risk change discount rates.