This article is sponsored by Brookfield Infrastructure.
Infrastructure debt has prospered into an established asset class in recent years. A market historically dominated by commercial banks with large project finance groups, post-financial crisis regulation saw private capital play a more central role in financing infrastructure at the senior debt level and open up the subordinated debt market.
Brookfield has been active in the infrastructure debt space for many years across the transportation, energy, renewables, data and utilities sectors, leveraging the strength of its leading global equity franchise.
Institutional investors now have a plethora of debt options, from direct lending to corporates to real estate debt. How does infra debt offer something different to LPs?
Ian Simes: The benefits of infrastructure debt come from the attributes of the underlying assets, in particular a degree of essentiality and high barriers to entry. Assets like ports, airports, toll roads or utilities, which people always need but cannot be easily replicated.
These assets will generally perform well in a downturn which differentiates the debt from that of other assets such as corporate debt or leveraged finance loans.
The upside for investors is that we’re making illiquid and highly structured loans which attract a higher spread, but the nature of the underlying infrastructure asset actually gives the investor a higher level of protection.
Hadley Peer Marshall: It’s also difficult for institutional investors to obtain exposure to infrastructure debt except through debt funds. Historically, you would have to be an insurance company with a team in place that lends directly, but now pension funds, insurance companies, family offices and other types of investors are all able to obtain access.
We see relatively few infra debt funds raised. Is the industry suffering from a lack of competition with only a few large players in the market?
HPM: What we’re seeing in infrastructure debt today is building momentum from investors, fund managers and borrowers and you need all three of these to build a strong market. Regulations have curtailed bank appetites for levered infrastructure deals and that has opened up many more options for others to come in as providers. We’ve also seen this development in the subordinated debt space, which didn’t exist 10 years ago.
All this means it’s a great time to be a borrower because all kinds of projects that might have struggled to raise financing from the banks can now attract funding via alternative providers.
IS: The senior debt space has become very competitive with debt funds, banks and the larger insurance companies and pension funds all providing capital for infrastructure debt. However, in the non-investment grade space, we see less competition and fewer funds and a much more modest supply of capital. This makes it a good place to be a lender.
What’s the near-term outlook for infra debt, given growing fears the global economy may be about to turn?
HPM: The benefit of infrastructure is that you are less exposed to the cycle, as the deals we do involve assets with stable, contracted cashflows and the characteristics of the asset class are generally uncorrelated to the broader market.
IS: From a recovery or economic loss perspective, infrastructure has historically performed well throughout all market cycles, including previous downturns, due to the quality of the underlying assets. However, what we can also expect to see in a downturn is that spreads will widen across the credit markets and, while infrastructure won’t be immune from this, we expect infrastructure credit will perform better with less volatility in comparison to other credit sectors.
In terms of greenfield transactions, we find that particularly during downturns, governments continue to prioritise the need to create more infrastructure and invest in existing infrastructure, so we would expect continued political support during a recession and for new projects to come to the market.
What about long-term prospects? Are structural factors such as bank retrenchment likely to drive opportunities for debt fund managers?
HPM: Long-term prospects for infrastructure debt are very good. We saw the original pull-back from the banks after the financial crisis and that has really opened up sponsors’ minds to alternative forms of financing. Historically they would just use senior debt and equity but today they are more willing to consider different types of debt and different structures that might be more suited to their financing objectives. In the future, we have Basel IV coming which is likely to see further bank retrenchment and this will open up more opportunities for experienced alternative players.
IS: We also need to consider that we are likely to be in a persistently low interest rate environment for the foreseeable future. In this kind of situation, investors need to capture more alpha from their portfolios, and private debt is an attractive way to do this. In an environment where base rates are higher, an investor might not be open to taking on an illiquid debt exposure to earn some incremental return, but with rates at or near zero, that proposition becomes much more compelling.
How are infrastructure debt funds innovating today?
IS: We see an infrastructure debt market that is naturally maturing and evolving to introduce a range of different strategies. Part of that is diversifying out of senior debt into junior debt or other structures.
HPM: In addition, there are more strategies looking at specific areas of infrastructure, such as renewables-only, inflation-linked opportunities, geographic preferences and so on.
How have investors adapted their approach to investing in infrastructure debt and how do you expect their demands to change in the future?
IS: Investors are definitely getting more sophisticated. Co-investment is happening a lot more often as investors begin to understand the sector in more detail and want to obtain direct exposure. We also see a lot of investors thinking more in-depth about where the money they allocate to infrastructure debt comes from. For some, it is a fixed-income allocation, for others it’s private debt and for others it sits in an alternative bucket, but we haven’t seen any firm trends develop yet for where infra debt allocations are coming from.
HPM: The amount of investors that are focusing on this asset class has massively increased and studies suggest it is one of the top strategies that investors want to commit capital to. There are a lot of investors out there looking to be better educated about the asset class so they can understand it and know what each different strategy can offer them.
Ultimately, we expect to continue to see growing appetite given the attractive risk-adjusted returns available in this low-yield environment plus the diversification that exposure to infrastructure debt provides.
Hadley Peer Marshall and Ian Simes are managing directors in Brookfield’s Infrastructure Group