‘Infra debt will be a learning exercise’

You’ve been doing infrastructure debt for quite a while, but interest in it has definitely shot up in the last year or so. Did you launch your most recent debt fund to capitalise on this trend?

SD: We clearly felt there was an opening in the market. Our interest in debt goes back many years and we were active in the leveraged debt space and in the buyout space. The flight to quality suggested that a focus on infrastructure debt – and particularly mezzanine debt – was something that might find favour and we do appear to have been ahead of the curve in doing that.

If you look at the 15-year trend in allocations and broadly break the world down into equities, fixed income and alternatives, then over the last 15 years, allocations to alternatives have gone up by about 15 percent. And by and large, that has been at the cost of fixed interest.

That trend has accelerated recently, because the flight to quality means that gilts and government bonds have become extremely keenly priced and investors in that sector are looking for better returns from infrastructure, but with instruments which have a risk profile and characteristics that are more debt-like.

I think [infrastructure debt] is going to be a learning exercise. The idea that infrastructure is a simple substitution [for fixed income] is a little bit too simple and there is a learning exercise which needs to take place, but it is occurring.

While somewhat simplistic, the idea that infrastructure is a good substitute for fixed income is gaining in popularity. Do you get this impression in your contacts with the limited partner (LP) community?

SD: It is definitely the case that a lot of fixed income players are struggling with the pricing of gilts and bonds – they really are. I have a real question in my mind about whether the debt associated with core infrastructure is going to be the best performing asset class over the next five years – just given the level of interest in it.

I think the returns available for modest risks at the moment are, for the right kind of investor, quite attractive.

Why did you choose subordinated debt for your recent debt vehicle?

SD: It’s an area where we are able to add significant value. The mezzanine or subordinated piece – it’s a different art and requires a different skill-set than the senior debt. It sits somewhere between debt and equity and the returns available are attractive.

It’s also the area which, in our view, benefits the most from dislocated markets. It sits very nicely with the idea that for moderate additional risks, you can generate quite significant additional returns.

With banks shying away from long-term lending, what do you think the debt landscape will look like in the future?

SD: I think it’s very much a ‘horses for courses’ issue. It’s certainly the case that regulation is pushing banks into the three- to five-year space, and probably more three than five, in terms of the tenor.

But finding a mechanism whereupon the debt tenor will be able to match the underlying asset is quite important, particularly for new projects. I think that will be key to the development of the infrastructure space.

There is certainly no unanimity on how regulators and governments are approaching this around the world. Some are using tax as a lever, some are thinking about deploying the government balance sheet in creative ways, underwriting or lending credit support in a way that will attract lenders, but it’s not settled.

From the perspective of a long-term debt player, do you think there is a sustainable infrastructure debt market going forward, or this a short-term trend, perhaps precipitated by bank deleveraging?

SD: I don’t think the anticipated bank portfolio sell-off has materialised. Yes, there have been some sales, but I don’t think to date we have seen the volumes people were expecting. I don’t know if this is a delay or whether people have overestimated the size [of the opportunity] and pressure [on banks].