Systematic Risk Factors in the Returns of Australian PPP Bonds

ROBERT J BIANCHI, MICHAEL E DREW AND TIMOTHY WHITTAKER, GRIFFITH BUSINESS SCHOOL, DEPARTMENT OF ACCOUNTING, FINANCE AND ECONOMICS, GRIFFITH UNIVERSITY

27 AUGUST 2013

This research examines the ability of systematic risk factors to explain the returns of bonds issued by Public−Private Partnerships (PPPs) in Australia. Despite the large number of PPP transactions being conducted in Australia in recent years, no previous studies have examined the systematic risk  factors that explain the variation of returns for PPPs in Australia or around the world. Using the systematic risk factors of term, default and liquidity in an asset pricing model, this study finds that systematic risks can explain between 37 per cent of the variation of bond returns of a toll road PPP  to 84 per cent of the variation of bond returns of a hospital PPP.

If increased adoption of PPPs in the provision of infrastructure is to be achieved, it is important that investors understand the systematic risk factors that explain the variation in PPP bond returns. This study provides a greater understanding of the relative advantages and investment merits of the  ownership of PPP bonds.

A review of the PPP literature reveals that previous studies have examined how the contractual structure of a PPP impacts on the pricing of debt, but have not considered whether PPP debt returns can be explained by systematic risk factors or idiosyncratic risks. Previous studies of project finance and  PPP investments, have explored whether investors price debt according to their exposure to the residual risk of the project.

We examined whether the systematic risk factors of term, default and liquidity can explain the variation of PPP bond returns. Our analysis suggests that these three systematic risk factors do indeed explain the variation of returns of PPP bonds and PPP bond portfolios.

This finding is important as, for the first time, the risk factors that explain the majority of the variation of returns for PPPs are quantified.

Our results indicate that the ability of the systematic risk factors to explain the variation of PPP bond returns is highest when the bonds are issued by PPPs with government revenue support and which do not enter receivership. When investors are exposed to risks that are not managed through the contractual  structure of the PPP, as evidenced by the lack of traffic demand in the Lane Cove Tunnel, the ability of the systematic risk factors to explain the variation in returns decreases as the idiosyncratic risk of a failing PPP dominates the pricing of its debt.

These findings provide several avenues for future research.

First, this study of PPP bonds and systematic risk factors is limited to six Australian PPPs. Performing a similar analysis on a broader sample of international PPPs would confirm whether these results hold or whether they are an Australian-specific phenomenon.

Second, this study includes a single Australian PPP (i.e. Lane Cove Tunnel) where revenue was not supported by government. This is also the sole PPP in the sample that failed financially. It would be informative to increase this sample size to include other PPPs where the revenues are not supported  by government. This would determine whether the lower adjusted r-square values observed for the Lane Cove tunnel bonds (compared to the adjusted r-square values of the other bonds in this study) are common for all PPPs that obtain revenue from user payments or whether this is a result of the tunnel’s  financial insolvency.

Finally, this study concentrates on examining the systematic risk factors that explain nominal bond returns. However, several PPPs issued other forms of bonds such as floating rate bonds and CPI-linked bonds. Given that these debt issues have been employed to provide financing for PPPs, further research  is required to examine whether systematic risk factors can also explain the variation of returns of these bond issues.