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14. Portfolio Optimization: Institutional Investors and Asset Managers

© New York University/Stern School of Business, CC BY 4.0 http://dx.doi.org/10.11647/OBP.0106.14

The foregoing risk and return analysis for infrastructure equity has direct implications for institutions and individuals seeking to invest in infrastructure as an asset class.

Here we focus on the 2003–2015 period and consider a large institutional investor such as a major pension fund that seeks to combine global stocks, bonds, real estate, and infrastructure in an optimal portfolio.

To make the problem more realistic in light of observed institutional portfolios, we impose maximum weights of 45% in bonds, 15% in real estate, and 15% in infrastructure.

Using the WCII definition, the minimum-variance portfolio holds the maximum 15% in infrastructure and 45% in bonds. It holds 36% in stocks and 4% in real estate. This portfolio has the same return as a 65%/35% stock/bond portfolio but has lower volatility and therefore a much higher Sharpe ratio: 0.62 versus 0.54.

The bottom line is that the historical data provide a compelling rationale for shifting traditional stock/bond portfolios toward real estate and infrastructure. Doing so in a way that maintains return and increases Sharpe ratio requires reducing the stock position and increasing the bond position.

It appears that institutional investors such as sovereign wealth funds, pension funds, insurance companies, and endowments do in fact tend to allocate similar fractions to real estate and infrastructure.

One study1 reports an average target allocation to real estate of 9.4% in 2014 (up 0.5% bps from 2013), with an intention to increase this allocation to 9.6% during 2015. The average fraction actually invested is only slightly lower, at 8.5%. These weights are close to real estate’s weight in the world market portfolio of investable assets.

The findings for Infrastructure are similar. Preqin2 reports that average allocation to infrastructure for institutional investors increased from 3.5% of AUM in 2011 to 4.3% in 2015. Target allocations to this asset class continued to grow in 2015 and stood at 6.3% of AUM in mid-2016 for those investors allocating to the asset class. Preqin also reports that allocations to infrastructure are likely to continue to grow in the coming years, with 44% of investors planning to increase the amount of capital they invest in the asset class.


1 See Funk, Weill, and Hodes (2014).