All roads lead to infrastructure debt

With interest rates remaining at historically low levels, more pension funds are looking for an alternative space to allocate capital.

Infrastructure is often the forgotten sector of private debt. A recent PDI survey of 70 European LPs committing to the asset class found just 3 percent invest in infrastructure debt, compared with 70 percent which allocate solely to corporate debt. The apparent lack of interest is arguably the symptom of an asset class in its early stages and untested during a downturn, but perhaps it is time investors look more closely at this niche strategy.

A report by Macquarie Infrastructure Debt Investment Solutions, a division of the Australian bank that covers infrastructure debt, says it is time to look beyond the ‘liquid/illiquid’ binary that often frames pension fund managers’ thinking together with the headline yield figure. Andrew Robertson, senior managing director at Macquarie, says pension funds should take advantage of the long-term cash inflows from investment grade assets with a low risk of default, especially as low interest rates appear not to be a temporary phenomenon.

The evidence suggests that institutional investors are beginning to move. UBS Asset Management recently held a final close on an infrastructure debt fund after collecting €570 million in capital commitments from 17 investors. Of those LPs, the majority were first-time investors into the asset class.

Across European senior debt strategies investors can expect returns of between 4 and 6 percent with higher yields available the further down the capital structure they go. Macquarie is fundraising for its second inflation-linked infrastructure debt fund, while UBS has said it will embark on a second fundraise once it has fully deployed the capital of the first vehicle. Other major players in this space include BlackRock, China Communication Construction Company, Westbourne Capital and Sciens Capital Management, who along with Macquarie make up the top five biggest fundraisers in infrastructure debt since 2010, according to PDI research.

One investor at a UK-based pension fund with more than £2.5 billion ($3.2 billion; €2.9 billion) of assets under management is plotting her first move into the asset class. Compared with corporate debt, the market does not feel overcrowded at the moment, she says, and, from a liability perspective, the long-term cash flows add to the attraction.

Under the Brexit shadow, some investors may be erring on the side of caution, considering that the asset class is tied to government decisions. But amid the uncertainty a consensus appears to be emerging that investment in infrastructure is necessary for economic growth. UK chancellor Philip Hammond said in his speech at the Conservative Party conference that “we need … careful, targeted public investment in high-value infrastructure” with the “encouragement of more private investment”. His opposition number, John McDonnell, shared the same sentiment and said £250 billion will be invested in the UK to “bring Britain’s infrastructure into the 21st century”.

This is music to the ears of funds investing in the space, but the experienced managers will be suspicious of political announcements until there are concrete proposals on the table. Nevertheless, it represents an important consensus that Macquarie’s Robertson said could possibly create opportunities in the private debt space.

As with private debt in general, many have questioned the longevity of infrastructure debt. Sceptics say that once interest rates go up or banks increase their lending, opportunities will decrease and funds will diminish. But the Bank of England’s reduction in interest rates by 25 basis points earlier this year suggests that low interest is the new norm. While infrastructure debt is conservative in nature and offers lower returns compared with other debt strategies, the low risk of default and predictable cashflows offer clear benefits for UK pension funds facing record deficits.