Could you give us a brief reminder of the history of infrastructure debt in Europe and the US?
RR: Infrastructure debt has been around for over 30 years and we’ve been involved for about the last 20 years. The Project Finance expertise originated out of Europe and the banks were initially the primary source of finance. In the late 1980s, the US power industry was deregulated and the European banks applied their expertise to the US and good relative returns were available. From the beginning, it was very energy-focused in the US, whereas in Europe it’s more about social and transport infrastructure and public-private partnership (PPP) programmes. The PPP has not really evolved in the US because most infrastructure originates at the state and local government level.
While supply of debt finance was traditionally supplied from the European commercial banks, they pulled back to some degree post-GFC. The notion of a rapid exodus of the banks has been exaggerated, and the Japanese banks have mostly filled the gap, but overall there has been a reduction in liquidity, particularly for long dated and lower rated credits. The banks are now very focused on high investment grade projects with shorter tenors, and that presents an opportunity for institutional investors such as ourselves.
How would you describe IFM’s position in the market and the way in which it is differentiated?
RR: We have a unique 17-year track record. Most of that is in Australia where the banks pulled back a long time ago and the pensions stepped in. But we were able to leverage that experience outside Australia post-GFC. We can do both fixed and floating rate debt, and we are now raising money outside Australia; we have so far raised around $3 billion from US, European and UK investors.
DC: We’ve been in it for a long time, through peaks and troughs. This is unlike much of the competition, which only came into the market post-2008. Generally, only one type of market condition has been seen since then, whereas we’ve seen the market go through different phases. We are operating in a low-yield environment but we have a global footprint of investors with different risk/return criteria. Therefore, we can pick and choose what kind of transactions we do. Others don’t have the same level of flexibility. A lot of people say there is a lack of deal flow in infrastructure but, because of our flexibility, we’re not so exposed to that.
Where are you seeing the most promising opportunities at the current time?
DC: You might say there’s more relative value in Southern Europe, but we’ve done deals in Germany recently, so that’s a contrary position. It goes to show we’re not wedded to particular markets. That said we do see opportunities in Spain, Portugal and Italy. In Spain there are a lot of banks but they do not have much appetite for long-dated infrastructure, while Italy is less banked. There are a lot of opportunities and not much capital being deployed.
Energy in Italy is especially interesting as prices are more expensive than in many other places so renewable energy can compete close to parity. A key test for us is whether a particular infrastructure asset is really needed. Because renewable energy normally needs a significant subsidy, it can sometimes give us pause for thought – but Italy should only need a relatively small subsidy. Even if you don’t want to go large in something like offshore wind, there is a lot of opportunity on the network side to accommodate renewable energy or to reinforce links between existing markets.
Australia is always active and there’s a lot going on. There is not much access to long-dated debt there; it’s typically around seven years. So there is a constant stream of refinancing need. That’s more interesting for Australian investors for currency reasons.
RR: The US is primarily an energy market and the big driver in the last few years has been oil and gas, especially natural gas. US generation is very old, it’s mostly coal assets. And now we have discovered vast amounts of natural gas. So we see a major build-out of associated infrastructure. Gas is a cheaper way to generate electricity than coal, so coal plants have been closed and natural gas has become a big market segment.
There is a big export market for LNG, translating to a market opportunity of around $60-$70 billion a year for infrastructure debt, but it has probably peaked as you can only build so many LNG plants. There is also a steady flow of wind and solar plants enabled by tax subsidies.
All the political volatility we’ve seen recently – is that a net good or net bad for infrastructure?
DC: It’s a net bad from a UK perspective. It’s difficult to be positive because of the level of uncertainty. Hinkley Point was called in for review by the UK government and held up. There are wide implications for energy policy in terms of what people are prepared to pay for it. But the willingness to take sterling risk might diminish in a way that creates opportunity for us. Also, if you’ve stayed true to your brand and invested in core infrastructure in developed markets then the underlying assets will be strong and governments will pay for them or subsidise them and you will get paid. That will ultimately prove the thesis around infrastructure debt being strong and stable.
RR: The US is different from Europe but there is the same level of political uncertainty and that’s never good for investments in general. With an election coming up we take comfort that infrastructure financing comes at the state level so it’s not really affected by who sits in the White House. The advent of PPP in the US will happen and the White House can impact that, but we’ve been in political gridlock for eight years during which time we’ve had record deal flow, so it’s all about the market dynamics ultimately.
Could you describe the process that you go through before deciding whether a deal is the right one for you?
RR: We now have large teams in London and New York and very good expertise in origination. We look for best relative value among the large volume of deals that we look at. In the US, 70 percent don’t pass the initial screening, and there are 25-30 percent a year that we look at in more detail. There was very good relative value in the US in 2015; this year, it’s the opposite with Europe looking better. After the screening, we do extensive due diligence for between four to eight weeks. Then we have a Q&A session where the deal gets probed about a week before going to the global investment committee.
How have you seen the attitude of investors towards infrastructure debt changing?
RR: We want to continue to educate the public pension fund market on the sustainability of the asset class. Infrastructure equity is well understood and accepted in the bank and insurance market. We have done master classes and invested a lot in our work with public pension funds and we now have more acceptance than we used to.
The difficulty is that most public pension plans have a fixed income bucket and an alternatives bucket. In general, infrastructure debt is not liquid enough for fixed income buckets, and it’s not a high enough return for alternatives. We can achieve mid – to high single-digit returns with a very low probability of loss. The return is in the middle of investor targets, but there’s no obvious bucket for it.
DC: Infrastructure equity will probably be at the lower-risk and return end of the private equity allocation so it’s easy for investors to get their heads around it. Infrastructure debt requires more work to make the switch. But earlier in my career, the conversation with investors was about what infrastructure debt is. Now, whether at a conference or seminar, you talk to investors who will have reached a view on it as an asset class. They might not do it, but there is a much better understanding of it than there was four to five years ago.
This article is sponsored by IFM Investors. It appeared in the October issue of PDI magazine.