They say it’s lonely at the top, but it’s certainly not lonely at the top of the cycle. Not only that, but, as our debt roundtable participants found, the crowd doesn’t really speak with one voice.
On everything from fund structures to risk appetite, there is significant divergence for managers to contend with. With the push and pull in full swing and some managers venturing into uncharted territory – all at a time when the global economy may be about to turn – discipline is more important than ever.
As more investors flock to the asset class, here are four trends to watch out for.
Everybody wants boring – but profitable
“Investors want core and very secured infrastructure, but they want a yield that no longer exists in Europe,” warns Celine Tercier, head of infrastructure finance at Ostrum Asset Management, in our roundtable.
So, what can conservative debt investors do? They have a few options. They can stick to Europe, but latch on to strategies that focus on parts of the market that have “had more trouble getting capital from the public and banking sectors”, as UBS Asset Management‘s head of infrastructure Tommaso Albanese points out. They can target core assets in developing countries, perhaps with credit enhancement and risk mitigants in the mix. Or they can take on more risk in search of higher returns, and move into junior debt.
Take a breather before you climb the risk ladder
There’s no doubt junior debt is popular these days, especially after AMP Capital showed you could raise some serious money with its $2.5 billion third junior debt fund, which closed in 2017.
But before you venture up the risk curve, you could do worse than heed the advice of debt veteran René Kassis, head of private debt at La Banque Postale Asset Management: “The junior/mezzanine space is quite narrow, especially now that you find a lot of liquidity on both the senior debt and the equity markets. You might end up taking an equity-type risk for a credit-type return.”
Junior debt is also not right for every investor. As Albanese puts it: “Subordinated debt has higher capital requirements. If you can structure something that is senior, giving you 4 percent [returns] with a 20 percent capital requirement – instead of 40 percent [for junior debt] – you get quite a nice risk-adjusted return.”
Beware leverage loans in infra debt clothing
If you do want to take on more risk, you should do so conscientiously. With all the core-plus, hybrid and ‘infra-like’ opportunities flooding the market, though, that’s easier said than done.
“We have seen assets financed in the leveraged loan market that then are sold to an infrastructure sponsor, and then return to the infrastructure debt market to try to get financed at a lower price,” warns John Mayhew, head of infrastructure debt at M&G.
Faced with such situations, the advice is clear: always look at the fundamentals of the asset.
Smells like 2007
Over the past 12 months, we’ve seen clear signs of leverage creep (though there’s much more equity in the system these days) and the rise of ‘covenant-lite’ structures (though there’s healthy debate on how aggressive those really are).
Rating agency arbitrage, however, is arguably the more worrying sign. As Glenn Fox, head of infrastructure debt investments at HSBC Global Asset Management, stresses: “It’s very clear that experienced sponsors are shopping to see who will give them the required rating at the highest leverage level. I look at markets such as Canada where I simply don’t believe the ratings that come out of that market. I saw one transaction recently where the degree of operational leverage is absurd for a transaction rated in the A category.”
Sounds like the bad old days, alright.
Write to the author at firstname.lastname@example.org. Also, watch out for our soon-to-be-published Debt Report, featuring a ranking of the 10 largest managers in the asset class.