AMP Capital on taking a subordinated approach

Mezzanine marries both yield and security as we near the top of the cycle, says Andrew Jones, global head of infrastructure debt at AMP Capital.

This article is sponsored by AMP Capital

What is your focus in terms of sector and geography and which areas are interesting in the current market environment?

Andrew Jones
Andrew Jones

Our strategy looks across all the main sectors within infrastructure – so, energy generation, transportation and regulated assets, as well as digital infrastructure. In fact, over the past 12 months, across both Europe and North America, we have been most active in the digital space, driven by the rollout of 5G. We have participated in deals involving fibre-optic roll-out, cell towers and data centres. That is a very significant opportunity and one that continues to grow with the ever-increasing consumption of data, video, cloud computing services and other emerging technology trends.

Power generation is the other sector I would point to right now. In North America, investment opportunities have been born out of the fundamental shifts in fuel sources to gas and in response to the new demands being placed on the electricity grid. In Europe, meanwhile, renewables have dominated, and both wind and solar have become areas of focus for us. We expect renewables to remain attractive, given the policy objectives that have resulted in a strong pipeline of projects with significant funding requirements.

What about opportunities in Asian markets?
We do also see an uptick in long-term opportunities in Asia as infrastructure investment in the region increases to meet the demands of growing populations and expanding economies. Where historically, infrastructure projects may have been funded by government, private sector funding is becoming more important.

Where do you play in the capital structure?
We have a dedicated focus on mezzanine and subordinated debt. We do not participate in the senior debt market. That is because our own observation has been that there tends to be quite a lot of liquidity in the senior infrastructure debt market, as banks aggressively seek to build portfolios and as institutional appetite for senior loans in the infrastructure space has continued to grow. There has been clear pricing compression as a result. The mezzanine space, however, is a far smaller and more niche market environment. We have found there to be significantly less competition for assets and, as a result, returns have held up particularly well.

What are the advantages of focusing on deals in which you can be the sole arranger and underwriter of mezzanine and subordinated tranches?
Our experience has been that if we are the ones negotiating the terms of an investment opportunity, structuring the loan and arranging the security provisions, then we are able to achieve outsized returns for our investors, while minimising their risk of loss. Our approach is very much to focus on directly originated opportunities rather than take part in pre-packaged deals through a syndicated process.

Has there been any of the same pressure on terms that we have seen in the corporate loan market?
That is certainly one of the conversations we have been having regularly with our investors and potential investors over the last year or two. They ask us if we have seen any watering down of terms because, as you say, the majority of corporate buyout debt being issued right now is covenant-lite in nature and with limited security.

Our own experience, however, has been that we haven’t see any dilution of investor protections in the mezzanine infrastructure debt space. The types of covenants, restrictions and security structures that we were able to achieve 10 years ago, we are still able to achieve today. We haven’t seen a great deal of change in terms and conditions, and we see that as a very positive thing when compared with other loan markets where protections for investors have deteriorated.

“We have found there to be significantly less competition for assets and, as a result, returns have held up particularly well [in the mezzanine space]”

Is that impacting the relative appeal of infrastructure debt for investors? What changes are you seeing in terms of the fundraising market?
Infrastructure, as an asset class, continues to be attractive due to the stability of the returns that are generated from assets that are providing essential services, with strong cashflows that are largely non-cyclical. And so, for lenders to infrastructure assets, not only do you have the benefit of lending money to those same defensive companies, you also have the additional security of having equity sitting ahead of you in terms of your risk of loss. Those two things combined have generated quite a bit of interest in infrastructure debt as an asset class.

What types of institutions are committing to infrastructure debt, and to mezzanine and subordinated strategies in particular?
The demand comes from a wide range of investors, right around the world. The vast majority of investors that support our strategy are either private or public pension plans and insurance companies, together with a meaningful number of the larger sovereign wealth funds.

What do those institutions have in common? In an environment where it is becoming difficult to find attractive risk-adjusted returns, they are searching for that rare thing: both yield and security.

High yielding infrastructure debt has emerged as an asset class relatively recently, commanding a higher yield than senior debt, with the same stable nature of infrastructure assets.

Are you seeing much innovation in the infrastructure debt space?
Outside of our particular area of focus, the broader infrastructure debt market has certainly seen a large increase in the types of offerings available to investors.

In addition to our subordinated private infrastructure debt strategy, AMP, for example, runs an attractive bond offering that gives investors exposure to traded, largely investment-grade rated, infrastructure loans in a more liquid approach. The proliferation of investment opportunities in the broader infrastructure debt space has certainly encouraged more investors to take a good look at the asset class.

How important are environmental, social and governance concerns to those investors and how do you integrate ESG into your investment decision-making?
ESG is a hugely topical issue and a growing area of focus for investors. Within our own strategy we have tried to stay ahead of that trend in investor demand. So, for many years now, ESG has been a very significant component in our assessment of investment opportunities.

One of the things we pride ourselves on is continuing to improve our approach to the role ESG plays in investment decisions. The tools we use and the way we consider ESG risk continue to evolve, as does the requirement from investors that ESG is right at the top of the list of things to consider when making a new investment. It is a critical element of our investment strategy today.

How has the geopolitical environment impacted infrastructure debt and how do you mitigate those sorts of risks?
Geopolitical developments will always have an impact on the asset class. The current range of issues – trade tensions between China and the US, Brexit and the rise of populism in various parts of the world – are all things that we factor into our risk assessments.

We are very familiar and are regularly reminded that one of the key underlying risks with regulated assets stems from the geopolitical environment, and so that is certainly a core element of our due diligence and our risk analysis.

In what other ways do you expect the asset class to evolve?
There has been very significant evolution over the past decade already. Today, there are multiple ways that investors can access infrastructure debt opportunities with various degrees of liquidity and duration. That has broadened the opportunity set for investors dramatically when compared with where we were 10 years ago.

We are also seeing other trends that we would expect to see in a maturing market. We are seeing more and more investors interested in investing directly, for example, and building up their own in-house teams. In addition, we are not only seeing more funds in the market, but also larger funds. That means that infrastructure debt funds can support the very largest investment opportunities being undertaken by the very largest infrastructure equity funds globally.

Are you seeing new sectors emerge, or else come to the fore?
We have seen a continual evolution of the types of asset being targeted in the infrastructure space. Our own corporate approach has been to try and define the types of opportunity that we want to pursue by the core characteristics that they possess – defensive, non-cyclical, stable companies providing highly visible cashflows and delivering essential services, often in a regulated environment. We are certainly seeing more and more sectors fall into that category. As I mentioned, a great example of that has been the rise in demand for digital infrastructure. The types of opportunity that we see in that space certainly have the characteristics that we look for.

What are your plans for the business in the next few years?
We have enjoyed great support from our investors and so have experienced significant growth. That has enabled us to deepen our relationships with the leading global infrastructure equity investors and allowed us to continue to support those clients as their businesses grow. We would expect that trend to continue. We have made a point, however, of staying focused on directly originated, subordinated opportunities, and I think that focus has allowed us to deliver consistent returns over a long period. We will therefore be making sure that focus is maintained in the coming years.

ArrowsDefensive debt
What are the biggest challenges the infrastructure debt industry is facing?

There is a broad expectation that we are nearing the top of the credit cycle and we can reasonably expect to see a surge in default rates, in particular from corporate loans, over the coming years. But we believe infrastructure debt has the defensive characteristics that will position it well to generate consistent returns, even in a downswing in the global economy and in an environment where corporate defaults are rising. The challenge for infrastructure debt players, then, is to help investors understand those characteristics that differentiate infrastructure debt from corporate debt. If we get that right, infrastructure debt could even benefit from a downturn.