BNP Paribas Asset Management: Debt stands on firm foundations

Infrastructure debt continues to perform strongly despite the macroeconomic volatility that dominates the market, say BNP Paribas Asset Management’s head of real assets Karen Azoulay and investment director Stéphanie Passet.

This article is sponsored by BNP Paribas Asset Management.

How is the infrastructure debt industry faring in light of the current challenging macroeconomic environment?

Karen Azoulay

Karen Azoulay: The past 12 months have been characterised by significant market volatility, driven by the combination of rising interest rates, high inflation and geopolitical uncertainty. War in Ukraine has also put a real emphasis on energy security, which has led to increased support for green energy sources as governments seek to reduce their reliance on Russian gas.

Against that backdrop, infrastructure has continued to demonstrate resilience, due to the essential nature of services provided and the monopolistic position that assets enjoy. Meanwhile, the underlying features of infrastructure assets, such as regulated revenues, have also been protecting the infrastructure debt asset class, especially loans with a floating rate format.

Finally, exposure to demand volatility is low in most sectors. That, coupled with inflation linkage, is also supporting infrastructure’s resilience. As a result, fundraising hit record new highs last year.

There has been a lot of focus on the energy transition, of course. How are you seeing that space evolve and what other areas are of particular interest?

KA: The energy transition is no longer talked about exclusively in the context of renewable energy generation. It now spans the decarbonisation of all infrastructure assets, and not only power generation.

Data crunching and infratech are key enablers boosting energy transition. This is particularly true in the transportation sector, with a move towards a green and smart mobility. Take, for example, electric vehicle charging platforms or the electrification of Europe’s rail network. These are both very hot topics today as part of the green mobility mega-trend and are definitely playing a role in the decarbonisation of the transportation sector. In parallel, these trends will continue to boost demand for renewable energy sources.

The energy transition also increasingly encompasses somewhat newer solutions including battery storage, biogas, distributed energy and energy efficiency, for which we are seeing interesting financing opportunities.

Hydrogen and carbon capture, meanwhile, are still at an earlier stage of development and offer a different risk profile. These two themes are more in the domain of equity investors, rather than debt, at least for this year, but we are following these market developments very closely. Climate change mitigation is at the core of the BNP Paribas Group corporate strategy.

The increased adoption of renewables also creates challenges, which are leading to additional capital expenditure needs in relation to smart grids, for instance, and the upgrading of transmission networks. These are all ways in which we are seeing the energy transition opportunity set evolve.

In addition to the energy transition sector, I would also point to healthcare infrastructure as an area to watch. In the wake of the pandemic and with public finances under pressure, we are seeing more opportunities in this area as infrastructure projects are needed to provide essential services that support societal healthcare, while bearing in mind these assets need to fall within the definition of infrastructure.

Is it challenging to align strategic priorities with ESG considerations in this kind of environment?

Stéphanie Passet

Stéphanie Passet: There can be a divergence between investors’ ESG and social impact objectives, and their desire to pursue higher returns. But I do believe we can align investment strategy with ESG considerations. 

Indeed, more than ever, investors are looking beyond financial performance and really appreciate the impact that their investment activity has in terms of benefiting the environment and local communities.

The renewables space is an obvious area where investors can pursue their ESG goals without necessarily compromising their return objectives. There is huge demand for capital in order to meet net-zero targets. 

But there is also of lot of competition in this market, putting pressure on pricing, so there is a higher need to be selective and it is important to be creative as well.

For example, we have noticed an interesting development in the structuring of renewables portfolio transactions mixing corporate power purchase agreements, regulated tariffs and merchant risk. 

We are seeing investors focus on assets with a measurable positive impact for the environment. As an institution, this is our primary focus as well. However, we remain cognisant of the regulatory backdrop which is constantly evolving when it comes to impact.

Meanwhile, investors are also targeting social objectives and we are seeing major demographic shifts in terms of where people are choosing to live and in terms of an ageing population. 

There are significant opportunities to invest behind these trends with healthcare infrastructure, for example, as mentioned earlier, as well as supporting fibre deployment in rural areas. 

What kinds of innovation are you seeing in the market today?

SP: Returning to the energy transition, the upgrading of grids, with the development of more interconnections, as well as distributed solar combined with battery storage, are interesting trends that will have important roles to play in meeting carbon reduction targets.

We are also seeing the development of thematic funds, focused on particular sectors or on areas of innovation – the circular economy and recycling being an interesting trend to follow. In addition, we see mezzanine debt funds financing development pipelines of renewables while historically financing has focused on ready-to-build projects.

Finally, another positive innovation involves the opening up of the infrastructure asset class to retail investors. This is an emerging trend and will require products that offer additional liquidity while balancing that with the reality that infrastructure has traditionally been a buy and hold strategy. 

What movements have you been seeing in terms of valuations through this period so far?

KA: Towards the end of last year, we did see a slowdown in M&A activity due to pervasive uncertainty and rising interest rates. However, this slowdown was not on par with the private equity market. As mentioned earlier, infrastructure has shown itself to be strongly resilient and the market remained active during the last quarter of 2022 and beginning of 2023.

Having said that, we may have some multiples being revised downwards and a slight repricing in some sectors such as telecoms, most notably in the fibre space. Our view is that the current environment will likely provide numerous opportunities to finance assets and projects that remain fundamentally sound from an investment perspective. 

By contrast, there is still a huge amount of liquidity pursuing the energy transition, so it comes as no real surprise that we have not seen any impact on valuations at all so far.

It is also worth mentioning that a lot of equity dry powder remains in the market, which should help maintain valuations. As a consequence, we do not expect to see any significant adjustments, although it will, of course, be sector dependent. 

What else do you think 2023 has to hold for the infrastructure debt asset class?

KA: The internal view here at BNP Paribas Asset Management is that we will see slightly negative growth in the eurozone through the second half of the year, followed by a recovery. The reopening of China following strict covid restrictions should help ease persisting supply chain issues and we expect to see a deceleration of inflation, albeit remaining above target for at least the remainder of 2023.

And, of course, in a high interest rate environment, debt is increasingly front of mind for equity investors, and we expect to be able to act as a key enabler for M&A, as well as supporting refinancing.

It is very important to assess these new risk-return profiles carefully, particularly in light of high levels of liquidity. We will continue to be highly selective in this space.

SP: Digital infrastructure and telecoms, meanwhile, continue to take share of the overall infrastructure market, currently up around 20 percent on pre-covid levels. We anticipate that market share will continue to grow. However, there may be a slowdown in fibre projects with the pipeline shifting more towards opportunities in towers and data centres.

Finally, we continue to see a noteworthy development in the convergence of private equity and infrastructure, with more corporate infrastructure-style transactions, with debt financing applied at different levels of the corporate structure. 

KA: The fundamentals of the asset class remain strong and we certainly plan to become more and more active in the space. We are seeing a plethora of interesting projects, including in the emerging sectors. The ability to assess the risks and opportunities that these  new sectors present is undoubtedly a differentiator.

Last year was exceptionally strong for fundraising. How do you see investor appetite playing out through the remainder of 2023?

Karen Azoulay: In the second half of 2022, inevitably, investors had to address portfolio reallocation issues as rising interest rates impacted the scale of fixed-income portfolios relative to private assets. As that plays through, what we are seeing in this period of higher volatility is a flight to high-quality assets at one end of the spectrum, as well as a flow of capital targeting more opportunistic assets as well.

In other words, we are simultaneously seeing investors targeting the most stable and resilient assets, while others target higher returns with opportunistic or cross-over investments, which infrastructure strategies focusing on the junior and subordinated space can offer. 

So far we are seeing no significant slowdown in fundraising this year. There is a growing institutional interest in private markets, in general. This is also increasingly true in the retail market. Within the private markets space, infrastructure is growing particularly strongly.