The fixed income debate: your views(2)

It’s no secret that investor interest in infrastructure debt is at an all-time high, with many new products coming to market to cater for that increased demand. It’s also no secret that part of this increased interest can be explained by the poor performance of equities and the tight yields gilts are offering in the current environment.

But a new current of thought which postulates that infrastructure debt, as an asset class, is the perfect replacement for fixed income has been gaining strength. So Infrastructure Investor decided to throw open the debate on our rebranded LinkedIn group last week, where we posed the following question:

Is infrastructure the new fixed income? Many pundits seem to think buying infrastructure debt is about as risky as buying gilts – except infrastructure debt pays more. What do you think?

Here are some of the highlights from the lively discussion that ensued.

Mark Hedges, chief investment officer, Nationwide Pension Fund, Nationwide Building Society 

No, it [infrastructure debt] obviously isn't the same risk as it commands higher returns. However, it can, in some instances, be considered lower risk than some other forms of credit, particularly where it has contractual obligations that are underpinned with cash-flows from the public sector, for example, in UK PFI/PPP schemes – though not immune from risk, lenders’ step-in rights to facilitate transfer to another operator do help to mitigate this. Understanding the detailed contractual arrangements particularly when the operator isn't meeting its obligations is thus critical for the lender/investor.

The other driver here is that these are generally long dated cash-flows that can help match liabilities. Though I suspect that the increased interest we are seeing may be more supply-led – i.e. changed regulatory requirements making long-dated project finance very unattractive for traditional bank lenders are leading them to try to create a market for assets they want off their balance sheets.

Nina Dohr-Pawlowitz, chief executive & head of fund placement, DC Placement Advisors

I think you need a very good and experienced [infrastructure] manager to manage the assets. Nothing is without any risk. Infrastructure assets are uncorrelated and therefore a lot of investors are interested in them to earn stable cash yields on a regular basis. Infrastructure debt especially has a smaller risk profile than infrastructure equity and when you find a good manager then you can earn as much as equity infrastructure brings.

David Cunningham, director, cleantech & renewables research, Westhouse Securities

The issue with infrastructure debt is liquidity and transparency in terms of future valuation. For instance, levered IRR's [internal rates of return] for operational solar parks in Italy and Spain are currently delivering 22 percent to 27 percent versus 6 percent to 7 percent in the government debt market. Valuation strains in PIGS [Portugal, Italy, Greece, Spain] are pushing German operational solar parks towards 11 percent IRR leveraged, with a natural Euro hedge built in – i.e debt, equity and income would be denominated in the newly high-valued German currency.

Amitabh Mehta, founder & director, infrastructure & funds advisory, Indus Blue Consulting

Infrastructure is definitely not as safe as gilts (though I wonder how safe gilts are these days). Bearing in mind that the majority of infrastructure transactions are government-led, the risk is certainly highly correlated to the creditworthiness of that government. Perhaps the comment above is about UK infrastructure deals. Certainly not the case abroad – take into account concession agreements, land acquisition laws, regulations, political uncertainty, etc, and you quickly realise why the statement would not be true in many jurisdictions.

*Curious about this debate? Why not participate in this and other ongoing topical discussions at Infrastructure Investor’s new LinkedIn group, which can be accessed here.