Ares Management: Critical assets and predictable cashflow

This article is sponsored by Ares Management.

Patrick Trears is a partner and the global head of infrastructure debt at Ares Management, overseeing an investment strategy across New York, London, Singapore and Sydney. He helped grow this strategy originally under AMP Capital, and since then, it “has got more and more momentum” and is now “quite a global presence”. 

Ares acquired the infrastructure debt business from AMP Capital in February 2022. Trears discusses the appeal of the asset class, the impact of rising rates, and the significance of sustainability.

How do you see investor interest in infrastructure debt?

Investor interest remains strong, and what we are seeing now is a flight to quality, in terms of investor appetite for infrastructure opportunities on the credit side. Investors are seeing the benefits infrastructure credit brings, the critical nature of the real assets supported, and the consistent cash yields.

In looking at it as part of the broader market trends and in light of rising interest rates, we are seeing greater allocation to infrastructure debt across the market.

We believe that we have one of the largest infrastructure debt strategies globally in terms of having capital raised. We have a global presence and a cycle-tested investment strategy that has demonstrated resilience.

Looking at the material risks for this year – interest rate risks, recessionary risks – I think infrastructure is designed to be resilient in terms of the broader market disruptions. The asset class continues to perform, and I believe that is why investors really like it. 

How have infrastructure debt structures evolved, and how has your strategy had to change to reflect that evolution?

They have been very consistent over the last 10 years. In the typical debt structure, you have senior debt, junior debt and then equity. Our position in the market has typically been as the provider of junior or subordinated financing to these projects.

The LTVs have remained very disciplined after the global financial crisis, when the banks were overleveraging transactions. That stopped in 2010. With the banks capitalising at 50 or 60 percent, the opportunity for subordinated debt capital grows, because these assets are so capital intensive. It is typically 10 percent of the capital stack.

We focus on doing our transactions on a bilateral basis. They are privately negotiated transactions with generally strong protections around covenants. Consequently, we have had no losses as of December 2022 on our fully realised investments through the IDF series, and an attractive track record.

Digital infrastructure is a huge movement in the infrastructure space at the moment. What makes it attractive and how do you explain its continuing growth?

That has been a trend that has really come into focus over the last two years, though we have been investing in digital infrastructure for the last decade. We were an early mover in the space, and as the asset class continues to deliver strong risk-adjusted returns, we have witnessed the critical nature of the assets and the predictability of the cashflow.

We are one of the largest providers of capital in the cell tower space globally, and we have also invested in data centres and fibre assets. This is critical infrastructure for people around the world who won’t want to disrupt their internet or cell phone service.

In terms of cell towers, these assets are continuing to increase in capacity. With the 5G revolution and the increased usage, there needs to be enhancement of the network.

So, there is strong contracted cashflow with highly rated offtakers. We have been quite creative in our ability to structure transactions and provide capital for the growth of these companies over the last seven years.

While digital and the energy transition get a lot of headlines, what are you seeing in some of the more traditional sectors?

We are anticipating a shift away from more traditional sectors, so we do like to focus on digital infrastructure and the energy transition. We are seeing some bespoke solutions within social infrastructure, and we expect to see them coming back more.

However, there has been a lack of investment across that space. Municipalities and government balance sheets are getting stretched given the lasting impact of the pandemic globally. There needs to be a whole new wave of investment in the hospital and care facilities sector. So, there is the potential for private capital to be a catalyst in the social infrastructure space, which could really start bringing on some new transactions. 

The benefit of some of these contracts is that they still have to be paid irrespective of whether the capability is used, so they are high-predictability cashflows relative to other assets. We are optimistic about how that will play out over the next 12 to 24 months.

How are you navigating the rising rate environment? Has this affected dealflow?

Dealflow remains fairly active, but we expect a wave of refinancings in the near term, so these transactions are getting repriced in today’s environment. Owners who already have their capital stacks locked down are not going to look for new debt this year. That being said, there are growth opportunities for builders of new assets who will be looking for new capital. So, between the refinancings and new builds, I don’t see dealflow slowing down.

Our strategy is floating rate, so we are benefiting from the uplift in rates. But we also require borrowers to put interest rate swaps in place, so that risk is mitigated. With the higher cost of capital, we are seeing the banks pull back from this space again. They are getting more cautious around LTV attachment points, so that is creating more opportunities for alternative investors as well. 

US regulatory standards actions, like the Inflation Reduction Act, will impact the infrastructure space. Do you have any concerns with current or pending regulatory changes as you invest?

In terms of risk across our portfolio, the majority of our transactions are on the private side. We lend to the private owners of infrastructure, and I think there is potential for new regulation to be favourable to build out these new assets.

The IRA was largely designed to help the renewables space, generally by providing tax benefits to producers that are supported by long-term contracts. The contracts are predominantly driven by corporations today who are looking for low-cost and green power. Our primary focus is on investments that are backed by these long-term contracts with predictable cashflows.

We avoid assets that could be subject to potential disruptions. But we think private capital is the way forward, and governments are gradually recognising that around the world.

ESG integration has become a huge focus for LPs over the last several years. How can you grow with this evolution?

ESG integration continues to gain greater importance and nuance each year. Ares aims to be a market leader in integrating ESG into the investment process and investing in the transition to a low-carbon economy. The company has built out a dedicated ESG function with professionals embedded across Ares’ asset classes. 

As part of this effort, we are focused on where we can have positive impact through our lending business. We closed our strategy’s first sustainability-linked loan in June 2022, a debt facility to EdgeConneX, which operates a portfolio of data centres around the world. The loan includes a margin adjustment, so the interest rate payable is directly correlated to EdgeConneX achieving pre-determined sustainability targets.

We believe we are enhancing alignment between Ares’ corporate sustainability commitment and that of our portfolio companies, which we believe is innovative and likely to grow in frequency in the market. It was the first such loan that was done in the infrastructure space, and we expect more of that to continue.

How do you view emerging markets?

Our focus has been predominantly on North America and Europe. We only invest in OECD countries, which includes certain countries in Asia, and Central and South America. We recently provided a subordinated tranche of the capital for a company’s acquisition of cell tower sites in Chile.

But we have taken a disciplined and selective approach to investments in emerging markets. Given the volatility we are seeing, we want to ensure that we are mitigating risk by lending to projects with well-capitalised sponsors, experienced management teams, and jurisdictions with strong contract law. We believe these markets will continue to support our focus on core infrastructure projects that provide a level of downside protection for our investors.