Guest comment by Claus Fintzen of AllianzGI
Until this year, the biggest challenge for infrastructure investors seemed to be the pandemic. The infrastructure debt asset class has grown particularly strongly in recent years and is a relevant component of many institutional investors’ portfolios. Most infra assets managed the pandemic well, but February 2022 brought a whole new challenge.
The invasion of Ukraine sent shockwaves through the world, but also through markets. Energy prices skyrocketing, supply bottlenecks and inflation as high as we have seen in 40 years have determined the economic climate since then. For the first time in 11 years, the European Central Bank raised the key interest rate in July and, with further adjustments expected, there are consequences for investors in the infrastructure sector.
When financing a company or project, investors must always include in their considerations what the conditions might look like in the future at the time of repayment. Project financing in the infrastructure sector is usually self-amortising, so there is no refinancing risk with higher interest rates. Corporate loans, on the other hand, are usually refinanced at the end of the term.
In the past, many issuers have taken advantage of the low interest rate environment and increased their leverage. They now have to refinance their debt capital in a significantly higher interest rate environment. Investors need to look closely at whether the company’s cashflow is sufficient to service the liabilities and at the same time maintain investment grade status.
If inflation and interest rates continue to rise, some companies could come under pressure. Long-term investors need to factor that in. At AllianzGI, when modelling the impact of interest rates, we pay close attention to how fast they are rising in the respective regions and then spread the risk through loans with different maturities, thereby trying to mitigate refinancing risk. In addition, binding conditions can be included in financing documents stipulating a reduction in the leverage ratio until refinancing.
In the case of regulated infrastructure, such as energy and water supply, revenues are often linked to the price index and can thus contribute to some income protection and portfolio stability for infra investors. The current energy crisis has also brought security of supply into focus. Security of supply must be brought into line with the energy transition. This requires considerable effort, both for existing infrastructure and that yet to be built.
Investment in infrastructure, especially green and transformative infra that supports the goal of climate neutrality, is more urgent than ever, but can no longer be funded solely from public budgets. The recently published Allianz Green Infrastructure Study shows that Europe has large investment gaps: France (1.3 percent of GDP per year), Italy (0.6 percent) and Germany (0.4 percent).
Private investors can help drive this. There is a broad spectrum of infrastructure investments that support companies on their path to climate neutrality. For example, AllianzGI has financed hybrid ferries, solar plants, the expansion of fibre optics and projects to increase energy efficiency. In order to gain access to such transactions, which are usually characterised by a high level of complexity, special expertise and financial strength are required.
Infrastructure projects are by nature long-term, illiquid and often sustainable assets. Their illiquidity premium can still generate higher returns than many government bonds, for example. Institutional investors need to keep a close eye on current developments and consider corresponding scenarios to be able to counter future crises. Under these conditions, infrastructure financing can still create considerable added value for investors. Especially in stormy times, it is important to set the sails correctly in order to stay on course.
Claus Fintzen is chief investment officer and head of infrastructure debt at AllianzGI in London