This article is sponsored by Edmond de Rothschild
Why should investors include an infrastructure debt allocation in their portfolio today?
I think the answer to that question is the same as it has been for the past 10 to 15 years: long-term, predictable cashflows; decorrelation from market events and a great deal of security in the way the underlying debt instrument is structured. That means a very low probability of default and high probability of recovery – I would say 100 percent for senior, investment-grade debt and around 60 to 70 percent for a yield-plus strategy.
Meanwhile, what makes infrastructure debt even more attractive these days is its intrinsic alignment with ESG objectives. Infrastructure has a vital role to play in meeting COP26 goals and saving the planet. Some might argue that the senior component of infrastructure debt ultimately has a similar risk profile to sovereign bonds with corporate spreads or higher, with the benefit that infrastructure debt is aligned with a growing and required focus on sustainability and ESG.
Bearing all that in mind, how would you describe investor appetite for the asset class?
Appetite is very strong. We see increasing demand from new investors looking to access the asset class for the first time. And we also see existing investors looking to grow their current allocations. Since 2014, we have raised five vintages within our infrastructure debt platform, Benjamin de Rothschild Infrastructure Debt Generation (BRIDGE) including commingled funds and managed accounts across senior and yield-plus strategies.
Each time we have amassed more money and the time between each vintage has decreased. BRIDGE-IV had raised €1.2 billion over Q1 2018-Q1 2020. BRIDGE-V, which is still fundraising, has raised in excess of €1.7 billion since Q3 2020. That is evidence of continued and growing interest in the asset class from investors. Particularly given the emphasis on sustainable development, infrastructure debt seems at the top of their list.
What are some of the more exciting deployment opportunities that you see today?
When we launched the business in 2014, we defined infrastructure as the energy transition, digital infrastructure, transport (with green mobility), social infrastructure (with energy efficiencies) and utilities (modernisation and greener). In that sense, our approach to portfolio construction hasn’t changed. But the types of opportunity that we see are evolving within each of those sectors, recently driven by sustainability goals. For example, we are now seeing a second generation of energy-transition asset, including floating offshore wind farms, hydrogen, hydro-electricity and battery storage. Technological advancements are creating new investment propositions. Sophisticated asset managers like us can capture such opportunities fast for our investors.
Meanwhile, digital infrastructure remains a prominent investment theme, addressing both the E and the S of ESG. We have also noted fresh opportunities in both the transport and social infrastructure sectors that are linked to green mobility and energy efficiencies. We were a first mover in green mobility three years ago and we are now seeing a more consistent flow of opportunities there. Energy efficiency is critical when it comes to social infrastructure (healthcare, sport and education assets), impacting the way that these projects are designed, built and operated. And utilities are now going through their own modernisation and energy transitions, moving away from fossil fuels. As an institution and asset manager we had a conviction to support that from the inception of BRIDGE.
A key word here is transition. We need to meet the CO2 emission reduction and global warming reduction as a priority and ahead of schedule, but some infrastructure will take time to implement their transition and infrastructure investors have a key role to play.
How do you decide when is the right time to move into some of these newer sectors, as a debt investor?
First, I would say it is about building conviction even before something becomes investable. We spend time talking to industrial and equity sponsors about technological developments. We work hard to understand the technical and regulatory risks associated with a new sector so that, at some point, we can decide that we have a strong credit story to tell our investors, as some key risks are mitigated and manageable. When we are pleased with the risk profile, we are ready to commit on behalf of our investors. If that is earlier than our competitors, then great. That means we can justify a certain complexity premium on our credit margin without taking additional risk.
How competitive is your part of the market? Has this changed and how do you differentiate yourselves?
That first-mover advantage can be important. We also ensure that we are continuing to grow the team, so that we have a broader coverage but without compromising the quality of our sourcing, structuring, monitoring, reporting and servicing. We have a seasoned team of investment managers, some of which come from the industry and others have advised the public sector, so we are tuned in to the latest regulatory developments. This also means we understand how regulators and the public authorities are thinking and behaving when implementing projects and acting if a credit event occurs. Engaging early with industrial and equity sponsors is key, as I mentioned. There is a credibility factor that comes with our ability to undertake analysis, and really understand a new technology or sector, giving us early and often proprietary access to investments.
You have already emphasised how important ESG is to infrastructure debt’s appeal. How exactly is it manifesting itself in the asset class?
ESG has always been integral to infrastructure. Thirty years ago, already, the first term sheet I reviewed focused on respecting the Equator Principles. And in the mid-90s we had to walk away from a deal because it would have endangered a protected species. That awareness has always been there. Edmond de Rothschild has already committed to and is at the forefront of ESG considerations. But fast-track to today and we now have regulation in place such as the European SFDR and the taxonomy directive implemented in March 2021. Sustainability has also further entered public consciousness and behaviour over the years, and there is a real willingness to reduce CO2 emissions and global warming.
Meanwhile, investors’ expectations around ESG have increased significantly. We need to demonstrate that ESG is embedded across our whole investment process from selecting investments to structuring the debt, where we can put specific covenants in place, as well as monitoring and reporting. We use external consultants to measure the CO2 avoided for every asset. We also classify assets in terms of their contribution to global warming reduction, as well as job creation, among other factors. That all forms part of a report that we produce for our investors.
Are there any macro risks that concern you, and how are you managing those?
I think hypervigilance is a permanent state of mind for an asset manager like us. Even when everything is going well across the portfolio, we always remain cautious and monitor any macroeconomic or political developments. We always worry about an operational incident occurring, for example.
Although the asset class is resilient, it is also our ability to “not sleep on our two ears” and be consistently wary of potential risks that contributes to the stability and long-term strength of our portfolios. You only need to look at how well they performed through a pandemic that has lasted far longer than anyone anticipated to see the effect of the diligence we apply at all times.
I think the true challenge for asset managers, however, is how we operate our funds and how we service our investors. That is where we need to ensure we are fully equipped with the skills we need – how we make distributions, how we report to investors, how we ensure that they have all the necessary information they require to comply with new regulations. That is where infrastructure debt managers will win or lose also.
What does the future hold for infrastructure debt as an asset class? And what are your plans as a business for the year or years ahead?
Infrastructure debt is a growing asset class and one that is experiencing technological shifts. We are seeing increased appetite from investors. The most sophisticated infrastructure debt managers, which we believe we belong to, have established themselves as alternative lenders to the banks, and that trend is not going to be reversed. Demand for infrastructure debt from borrowers is also on the rise, particularly given the ambitious infrastructure plans announced by several countries in support of the energy transition across the globe.
In terms of our own business, we will continue to deploy our current senior as well as our yield-plus strategies, the latter more akin to the BB space. In addition, we will begin to invest outside our already very broad definition of Europe. We have concrete plans to invest in the US. We also plan to invest in Asia, Latin America, Australia and the Middle East as part of global mandates, so we are very much globalising our offering as per our initial plan.
How is infrastructure debt likely to perform in a higher interest rate, higher inflation environment?
I think the important question is, how will infrastructure debt fare when compared to other fixed income solutions? Will we remain competitive? And will we continue to bring a premium to investors? The answer is yes. There are ways of protecting yourself from inflation in an infrastructure project. You can also argue that inflation may improve the cashflow position of some assets, which can protect us as lenders as there might be more cash available to repay us.
In addition, you can structure CPI-linked debt in some jurisdictions, the UK being a good example. That means you can manage and capture that inflation component. The higher inflation trend has already begun, and I think we can see that investors still consider infrastructure debt to be an attractive solution for the short, medium and long term.