As the merits of infrastructure debt get better understood, a strong interest for the asset class is taking root across Asia’s largest economies, panelists said at Infrastructure Investor's Tokyo Forum last week.
With the impact of fresh regulation in Europe hitting the region in significant force, the bank’s focus on short term funding was highlighted as a major factor behind the growing financing gap observed in Asia – creating space for asset managers capable of offering long-term debt products.
“Out of the amounts that have been spent on infrastructure in the region over the recent past, two thirds have been provided by the debt market, twice the size from equity. Of that, 90 percent has been provided by banks historically and the rest has been provided by capital markets,” noted Ross Pritchard, investment director at Melbourne-based Hastings.
Ajay Sawhney, president and chief executive of Mumbai-based asset manager of IDFC Capital, a subsidiary of IDFC Alternatives, reckons India will have financing needs of up to $400 billion if its economy grows at between 7 and 8 percent in the next decade.
Against this backdrop, panelists saw two main advantages to investing in infrastructure debt: lower risk and attractive yields.
“In India today, you have 10-year bonds trading at 50 basis points or 750 basis in absolute yields in rupees. But when we are financing projects, we are looking at yield pick-ups of 300 to 350 basis points, all with the sovereign spread,” noted Sawhney.
Most importantly to him was the security which infrastructure debt provided creditors with. “When things do get rough, our investors sit high up there on top of the list, as they would in project finance deals.”
This perspective was echoed by Yuji Kano, senior investment officer at the International Finance Corporation (IFC), the investment arm of the World Bank. He stressed that his investors benefitted from significant protection when investing in infrastructure debt, thanks to such guarantees as six-month debt service reserve accounts or financial covenants like debt-to-income ratios.
Panelists highlighted that, although the forecast IRR of infrastructure equity and mezzanine is typically higher than the forecast yield of senior debt, there is generally less contractual certainty as to the minimum return of equity and mezzanine.
The contractually promised yields of senior debt would not be received only if the borrower became insolvent, whereas in the case of equity and mezzanine investments, pay-outs can be reduced or delayed in situations far less extreme.
Whereas the stability of yields was deemed comparable to the fixed income asset class, however, one challenge with investing in infrastructure debt was that benchmarking related debt for price and returns was much more difficult than for government bonds.
“Whereas you can go and check on Bloomberg how your bond is performing there are no such markers for this type of investments. What we often do is instead of going on the secondary market for such markers, we use simulated similar types of portfolios to compare results,” explained Pritchard.
In response to the too often shared perception that illiquidity is a strong downside for the private debt investment category, Sawhney however argued that when it came to exiting public bonds in the secondary market, “sometimes things didn’t always pan out as they are expected to either”.
Kano also made the case for the growing reliability of the secondary markets, confirming his conviction that as market risk perception changes transactions would rapidly pick up. Although banks are currently the main buyers of IFC’s products, he expected things to change soon.
“When it comes to India, it is only now that the regulator is allowing the insurance sector to invest in infrastructure significantly and we are expecting this to make a big difference,” concurred Sawhney.