In a world where government borrowing continues to climb in many markets, the risk that comes with debt investing is compensated for by potentially significant returns. In the energy space, the important role that infrastructure debt can play in supporting much-needed developments has long been recognised, and the performance of infra debt funds, even during challenging macroeconomic conditions, has provided some form of stability – particularly of late.
“Through the turbulence of the covid-19 economic shutdown, unprecedented monetary easing, inflation and supersonic pace of rate hikes, infrastructure debt has demonstrated its appeal, providing excellent credit resiliency with no material losses,” says Jorge Camiña, partner and head of sustainable infrastructure credit at Denham Capital. “Over recent months, as part of the [US] Fed’s tightening efforts, fixed-income long duration portfolios have experienced a material repricing to reflect a new interest rate environment, with bond prices dropping 10-20 percent for long duration assets. Infrastructure debt is no exception.”
The relative resilience of infrastructure debt when compared with public spreads (and even some other private debt markets) over the past 12 months has captured the attention of many investors. With the energy transition gathering pace, this resilience is only likely to strengthen for certain projects.
Given infrastructure’s traditional resilience, recent market turmoil has given investors plenty to think about. Of late, for example, the infrastructure debt market has changed markedly, driven by a macroeconomic climate substantially different from what came before.
“Recent rising interest rates and other economic issues have led to fewer bankable projects and a high hurdle rate,” explains Gautier Despret, regional head of private debt for Europe at IQ-EQ. “This has meant that despite a lot of dry power being available, there has been a fall in demand for, and return on, infrastructure debt.”
The pandemic created some anxieties for investors in infra debt, as it did for supporters of all asset classes. “During covid, some infrastructure sectors did experience a level of stress, such as transport assets, but with most of them, sponsors made sure there was enough liquidity, and lenders worked with them to minimise the turmoil,” says Pieter Welman, Barings’ head of global infrastructure. “These are strategic assets, so demand a long-term view. That is why infra debt has delivered good performance for over a decade now.”
But even sectors that are viewed as being particularly forward-looking, such as sustainable infrastructure, have experienced something of a wobble in recent times. Across 2022, for instance, the global sustainable debt market posted its first decline on record, with borrower appetite damaged by higher interest rates.
The draw of debt
Sustainability-linked bond issuance fell some 19 percent last year, to $863 billion, and Fitch Ratings is not alone in thinking that company debt issuance will be delayed during the year ahead as recession fears continue to loom.
Market conditions are not so unsettled that infrastructure debt is seeing no activity, however. “In fact, despite some challenges, we are seeing that the market continues to be an attractive investment option for investors looking for diversification and hedging inflation potential because cashflows are usually inelastic or are indexed to inflation,” Despret says.
Regulatory changes have also helped. Returns on private infrastructure debt have increased significantly in view of Basel III reforms, which have impacted banks’ profitability regarding long-term loans. “Banks and their regulators like the infrastructure debt asset class and this allows lenders to maintain a large book,” Camiña adds. “This is opposed to other private credit strategies that are more prone to straight disintermediation, such as leverage finance and securitisations.”
Not all infra debt is equally attractive, however, with some assets attracting more attention than others. For example, it seems there is currently a substantial amount of capital available for early-stage renewable energy developers.
Over the past two years, there has been a flurry of activity in the acquisition and recapitalisation of renewable energy development pipelines across the US and Europe. This includes the raising of $5 billion in infrastructure debt capital by Ares Management at the start of this year, with its structured sustainability-linked debt facilities.
Other examples of infrastructure debt financing include the closing of a $450 million debt facility by QIC and Cypress Creek Renewables (CCR) to fund CCR’s solar and storage project pipeline. Similarly, debt financing for renewable energy platform Origis Energy and the Eurazeo Transition Infrastructure Fund demonstrate investor appetite for infrastructure debt in the power and energy spaces in particular.
Infrastructure debt also offers a range of risk profiles for investors, without the volatility that generally accompanies equities. For example, some junior infrastructure debt investments in Europe now offer returns of over 7 percent.
“The risk-return of infra debt has changed a lot in recent times,” Welman says. “If you are able to offer investment-grade debt at 3 percent, say, there is still some benefit but when this figure reaches 5, 6 or 7 percent, it is a different ball game. You are then witnessing returns that are not far off core infrastructure assets.
“The risk-reward has definitely improved over the last six months. This is not to say that the long-term case for equity isn’t great too. But there has definitely been a recent shift in the risk and reward profile of infra debt.”
In the post-pandemic world, especially in developed markets, infrastructure debt has provided the highest levels of risk-adjusted return, boosted by the transport, renewables and social sectors and driven by a market focus on decarbonisation and economic recovery. Since 2015, the yield advantage of infrastructure-related debt has outperformed the overall long-term fixed-income market by some 7.3 percent, according to figures from Fiera Capital, suggesting last year’s decline could be little more than a blip.
Despite ongoing uncertainty regarding the macroeconomic picture, the total market value of infrastructure AUM has grown rapidly from $170 billion in 2010 to $1 trillion in 2021 and is poised to go higher. This is being driven by surging investor demand and the need to decarbonise the global economy.
“Alongside the energy transition, a boom in home working, e-commerce and online entertainment during lockdowns will lead to more demand for connectivity infrastructure such as data centres,” Despret says. “Other social infrastructure transactions, such as affordable housing, will also be a boost for the infrastructure asset class.”
However, while infrastructure projects continue to grow in high-income countries, they are declining in low-income nations, where much of the world’s infrastructure needs lie. In fact, investment in infrastructure projects in middle and low-income countries is falling. Currently, political risk, alongside a lack of measures to mitigate it, serves as a barrier to investors, meaning these lower-income countries remain unable to issue the infrastructure debt they desperately need to finance their projects.
“In the next few years, we expect to see a situation where governments and multilateral development banks join together to provide guarantees for projects and play a critical role by providing a statement of viability, stability and creditworthiness,” Despret says. ”If the situation resolves itself in lower-income countries, debt will be able to play a similar role to that seen within transitionary projects in high-income countries.”
As Despret touches upon, this is a hugely exciting time for institutional investors in private debt. When compared with government bonds issued in developed economies, infrastructure debt has delivered impressive financial performance over the past decade – a potent mix of attractive returns and relatively subdued risk.
In fact, infrastructure debt, which accounts for roughly 80 percent of all infrastructure investment, has delivered an average annualised return of 6 percent over the past 10 years at an average annualised risk of just 3.3 percent, according to rating agency Moody’s.
“The essentiality and credit resiliency attributes of the infrastructure asset class set it apart from any other private credit strategy, particularly in the context of an economic slowdown,” Camiña acknowledges.
“When you add to this the unprecedented generational capex wave in energy transition and digitalisation, as well as overall policy tailwinds, you find a unique combination of downside protection and growth at the best real yields for the asset class in a decade.”
Case study: Supporting sustainability
In November last year, Eurazeo announced the first close of the Eurazeo Transition Infrastructure Fund (ETIF), an SFDR Article 9 fund.
€75 million of commitments came from the European Investment Fund. Eurazeo has itself made a commitment of €100 million, and several institutional investors have supported the fund as well.
The ETIF has already allocated substantial amounts of capital to a portfolio of three sustainable infrastructure companies: Ikaros Solar, a Belgian developer of rooftop solar panels; Resource, a joint venture to develop a plastic waste sorting plant in Denmark; and Electra, a French operator of electric vehicle charging points.
Backed by InvestEU, a programme specifically designed to support sustainable investment, innovation and job creation in Europe, Eurazeo’s fund adopts a holistic approach across the transition infrastructure space, supporting the movement towards decarbonisation, energy sovereignty and a more sustainable future.