Q What does infrastructure debt offer to investors?
Infrastructure debt offers investors the combination of long-dated, non-cyclical, investment-grade risk profile opportunities, coupled with superior returns to comparable corporate benchmarks and better credit characteristics. The asset class exhibits lower default rates and higher recovery rates than comparable corporate credit.
For example, the average recovery rate for infrastructure debt is about 73 percent compared with about 53 percent for corporate credit according to Moody’s data for BBB credits from 1983 to 2016. Over this same time period, infrastructure debt has also demonstrated more resilient credit performance with rating volatility of less than half that of corporate debt1. This can be seen in the chart on p. 27.
Q Therefore, which types of investor tend to be interested in infra debt?
Institutional investors with long-dated investment horizons, particularly European insurance companies which are very attracted to the asset class because of the favorable capital treatment under Solvency II.
Q How much have infra debt allocations been growing – and are there reasons why you would expect them to grow further?
Yes, we see increasing allocations to infrastructure debt and believe they will continue growing. The growth is fueled by financial constraints faced by many governments, bank structural deleveraging to comply with Basel III, together with considerable investment requirements, which are driving a shift towards increased private sector participation in the financing, operation and ownership of infrastructure assets.
Institutional investors are filling this capital gap as they need predictable, stable, long-term cash flows, particularly in this “lower for longer” interest rate environment. We are seeing first-time investors wanting to put more capital to work and new investors making investments into infrastructure debt as they have gained more knowledge and experience of investing over the past few years, and recognise its favorable characteristics.
Q Which types of investment is infra debt most closely correlated to – and therefore competing with for capital?
Given infrastructure debt is a new asset class, one of the challenges investors face is finding its place in their asset allocation. We believe that infrastructure debt is an attractive and complementary alternative to traditional corporate debt. Infrastructure debt is increasingly recognised as part of the broader private debt offering; a new and fast-growing asset allocation in institutional investors’ strategy. Real estate debt and direct corporate lending are other forms of private debt, but typically more risky than infrastructure debt.
Q What kind of return can typically be expected, and how has the performance of infra debt been to date?
Investors should expect managers to generate a pick-up versus investment grade corporate debt of at least 150 to 200 basis points for senior secured infrastructure debt. This can be achieved by identifying and investing in dislocated market segments affected by a lack of capital supply, being proactive in sourcing and accessing private/proprietary debt financings in the primary market and ensuring direct involvement in structuring to identify and mitigate risks as well as avoid intermediation costs along with active monitoring of investments.
Q On the investment side, which sectors and geographies look attractive currently – and are there any which, for some reason, look less attractive than before?
Infrastructure financing in Europe has been typically dominated by banks which are now in retreat due to regulatory and financial pressures. This is particularly the case for mid-size transactions in local European markets where the ability to provide dedicated origination and structuring capabilities by non-banking investors could well result in bank disintermediation.
Q How strong is deal flow overall – is there sufficient opportunity to deploy the capital?
We are seeing many opportunities to deploy investors’ capital in Europe in the senior secured segment of the capital structure. Our current strategy has successfully deployed nearly €200 million year-to-date across four different investments ranging from the refinancing of a ferry operator connecting Sweden to Denmark, investing in a Spanish solar plants opportunity, an Irish motorway and the financing of a portfolio of bulk liquid storage terminals in France and Iberia.
We expect to put a further €50-75 million into the market across at least one to two more investments before the end of the calendar year. We emphasise brownfield assets where cash flows are more visible and able to generate yield immediately, but we also invest in greenfield opportunities.
Q Is there much competition to do deals, and how is the pricing environment?
Our key competitors are still banks as they were the primary source of financing for this type of investment until asset managers and private capital started offering financing solutions that compete with traditional bank capital. Our capital is complementary and an alternative source of financing to companies.
We compete well by focusing on primary transactions where we have a direct dialogue with the borrowers, offering them favorable terms such as superior speed of execution, dedicated structuring capabilities, a pragmatic approach to negotiating terms and a true focus on long-term partnerships, while avoiding fee churn. This approach is critical to how we differentiate our offering from the competition and is demonstrated by our ability to generate superior returns.
Q How much of an impact do political and regulatory developments have on the market? Is now a particularly challenging time due to various political upheavals?
Infrastructure investment is quintessentially inter-linked with political and regulatory risk. The current economic environment is offering a temporary and modest relief from the worst of the crisis. But the nature of this asset class means that we invest for the long term and always think about our investments through the economic cycle.
When a country’s regulation is considered to be fair and sustainable, the related infrastructure will benefit from low probability of regulatory changes, although its returns could come under pressure. We are instead very cautious of sectors where the tariffs or subsidies are too generous and/or motivated by moving liabilities off-balance sheet, such is often the case in many PPP/ PFI transactions.
Q How do you see infra debt developing over the next five years?
There are growing infrastructure capital needs as well as more private investors looking for such opportunities. In the last few decades, the world’s population and economies have been growing at an ever-faster pace, creating bigger gaps in public spending for social services and infrastructure.
As private capital will keep increasing its participation in the investment and financing of infrastructure projects, the sector will evolve and mature, becoming more institutionalised and transparent in risk evaluation and available debt instruments – most probably a similar development as has been seen in the real estate market.
Q Are investors by now entirely familiar with the asset class, or is an education process still required?
Investors still require further education on this asset class, especially with regards to how the risk-return profile of infrastructure debt is often more stable and sustainable over the long-term than other comparable corporate debt.
European regulators and government agencies have, for example, even pointed out themselves that infrastructure debt should deserve a greater percentage of allocations in institutional portfolios, but we’re not yet seeing this as investors are continuing to familiarise themselves with where to allocate illiquid private debt and assess the respective capital requirements.
Q How are infra debt transactions typically sourced?
We source infrastructure debt opportunities from a variety of channels, mainly through direct investments, usually involving in-depth credit analysis and structuring work. We typically interact with banks and equity sponsors but also with local advisors, sector consultants and directly with project companies.
Our team’s combined 70-plus years of experience means that we’ve built up an expansive list of useful relationships which allow us to benefit from exposure to a wide range of opportunities in the market.
Q Are there sectors that you see as potentially attractive but which you have not yet invested in?
We are very open-minded as to which sectors we’re willing to invest in. To date, we have actively invested in a broad range of sectors such as ferry and port transport, elderly homes, power, motorways, renewables, liquid storage and car parks. We would have liked to increase our exposure to social infrastructure for its long-term contracted revenue aspect, but it has experienced too much credit spread compression which has deterred us for the time being.
Q Do you always favour investing alone, or are there times when teaming up with others makes sense?
Due to the size of transactions we get involved in, we don’t always invest alone. We typically tend to invest in club deals alongside two to three other like-minded investors which have the same alignment for long-term “buy and hold” investments. Again, the depth of our experience in the market means that we’ve built strong relationships with lots of other parties and we frequently bring deals to one another for consideration.
Q What are the most important considerations when it comes to portfolio management?
Aside from achieving a healthy portfolio diversification across sectors and countries, we believe in the importance of maintaining close and continuous relationships with the management of the invested project companies in order to monitor first-hand the project performance but also participate in eventual debt refinancing and business expansion, should such requirements arise.