IFM Investors: ‘Resilience in the face of the storms’

With Brexit negotiations ongoing and political controversy swirling in the US, what is the current investment climate like for infrastructure debt? We catch up with John Carey and Rich Randall of IFM Investors to get their take on the situation.

Given the global political volatility we see currently, what are the implications for infrastructure debt investors?

JC: From a European perspective, we have for a while looked at the region as a series of markets where you can analyse risk and price accordingly. More recently, in the UK, we have seen political risk become higher than it was five years ago. But has that come through in the terms and conditions? Not in a material way.

With Brexit, there is still a lot to be determined. Our sweet-spot is essential infrastructure and that was attractive before Brexit and has remained attractive after Brexit. However, one example of concern would be airports, which we are assessing differently to 18 months ago. Political risk in that sector has led to different expectations for Brexit-related reasons.

RR: It’s a different environment in the US, with a lot of talk around the Trump administration. Political volatility hasn’t really spilled over into infrastructure. The economy is doing well and there is an adequate supply of capital. What’s acknowledged is that something needs to be done about US infrastructure but, while the federal government can provide

leadership and funding, the key decisions really come down to the state level – and, on a state by state basis, you find very different attitudes.

Are there parts of the world that have become more or less attractive over the last year or two?

RR: We have a focus on OECD countries in North America, the UK, western Europe and Australia and, in doing so, we cover by far the largest infrastructure markets in the world. From one quarter to the next you may see more opportunities in one particular market but over a long period Australia, Europe and North America have accounted for around a third each. Earlier in the year there was good US deal flow. That’s come down a bit lately with more capital chasing fewer deals.

JC: In Europe, there has been some recovery in the southern markets. There is growth and greater resilience: Moody’s has put Portugal on a positive outlook and the Spanish economy looks stronger than it has in the last three or four years. It’s the area of Europe where we’ve seen the most change.

In the UK, there is a flow of opportunities but it’s not breaking any records. A lot of investors are still comfortable with the UK as an investing environment over both the short and long term. However, the European Investment Bank may no longer be as big a factor in long-dated infrastructure and that needs to be watched.

How do you view talk of nationalisation, e.g. rail in the UK, and what appears to be increasingly polarised political positions between left and right?

JC: We don’t dismiss it out of hand. But in UK rail we would make the point that the vast majority of the industry, from a capital value perspective, is in public or quasi-public hands so there is an optical aspect when people talk about nationalisation. Moreover, we certainly wouldn’t consider ourselves natural investors in rail franchises.

Water regulation has evolved in terms of regulated returns, which in part stems from greater scrutiny on efficiency and performance which has a certain logic to it. But it has squeezed cash flows from the earlier determinations.

If you accept that the rule of law is robust in the UK, then how would the UK government go about large-scale nationalisation? There would be very real budgetary barriers.

There continues to be much reflection over the appropriate role of regulators. How has that affected what you do?

RR: I think the take of the current US administration is to reduce federal regulation that may hinder timelines in terms of developing a project. That is a necessary move as it can be too confusing and complex to get something like an environmental impact assessment. They can see there is room for improvement and they are trying to cut the red tape.

There has been some controversy around greenhouse gases and trying to strip away emissions rules. The thing is, the federal government can only issue guidelines which need to be implemented by the states and some of the states, such as California, are going their own way by adhering to the Paris accords. In this way, the states will become incubators. California has always been ahead of the curve.

JC: We still see water as attractive as it’s resilient and the primary impact is on equity rather than debt in terms of returns. There will be an increasing focus on the nature of the sponsor group and there are increasing numbers of truly long-term investors which looks positive from a credit perspective. You get misalignment when investors have a short-term outlook. In continental Europe, we think long and hard about renewable energy regulation. We are comfortable with jurisdictions which have honoured the regulations over time but we’re cautious about those which have not. We will look carefully at the track record in terms of how we price risk.

What is the level of opportunity today and how do you decide which investments make sense for you?

RR: We stay in constant contact with our regional offices and screen and vet across the regions. We track where the best relative value is over time. In terms of deal flow today, the US has slowed down compared with the last couple of years there were opportunities in LNG export and natural gas based on the shale revolution. But that area now has an over-supply issue and is slowing down. We are seeing more transport and social infrastructure deals at the state level, with up to 10 potential deals a year compared with just one or two a few years back.

JC: There is still value in credit that is more complex and where you need skill to analyse and underwrite it. When it comes to straightforward credit, we can certainly detect an increasing level of capital looking at those assets, including corporate fixed income investors as well as infrastructure specialists.

We see offshore wind as the most competitive sector in Europe despite lots of deal flow. It’s a tough sector in terms of risk/return. We still hope there’s a good story there because vast sums are needed from both banks and non-banks.

When you speak to investors, what are the questions about infrastructure debt you tend to hear most often?

RR: The biggest thing is the ability to deploy capital and get a decent return. Private equity and hedge funds have not returned what they promised and the public markets are expensive. Infrastructure debt is therefore attractive to a lot of investors amid the global hunt for yield. But the key factor is whether managers can deploy the capital and get a reasonable rate of return.

JC: There are issues around ESG and stranded asset risk, given that there is increasing scrutiny of exposure to legacy fossil fuel risk. Also, ESG is not limited to Europe any more. In infrastructure, we can customise what we do and it lends itself well to ESG compliance in areas such as energy, transport and social infrastructure.

Has the perceived role of infrastructure debt changed at all? Is there scope for it to become a still-bigger part of investor portfolios?

RR: In certain parts of the alternatives universe there is a wall of capital and it can destroy premiums. But we’ve not seen that really happen in infrastructure debt. The commercial banks can’t play in long- dated infrastructure and they’re potentially the largest pool of capital. You only have institutional investors that can lend longer term, and that makes it sustainable.

JC: The European twist is Solvency II. The way that regulators have given both debt and equity more benign treatment must give insurance companies encouragement. Does that increase in capital from insurers lead the market to tighten in pricing? We’re not seeing that yet.

This article is sponsored by IFM Investors. Rich Randall is New York-based global head of debt investments and John Carey is a London-based investment director at IFM Investors, an asset manager which operates across Australia, Europe and the US.