Edmond de Rothschild: The power of holding the pen

Asset managers that deployed through 2020 are in an enhanced negotiating position to optimise terms, says BRIDGE CIO, global head of infrastructure, real assets and structured finance and EdR UK CEO Jean-Francis Dusch.

This article is sponsored by Edmond de Rothschild Asset Management

The past 12 months seem to have been exceptionally busy for you, despite a global pandemic. How was it that deployment remained so strong when the wider market appeared to wobble?

Jean-Francis Dusch
Jean-Francis Dusch

You are right – 2020 was actually a record year for us in terms of deployment. We invested around €800 million in 19 assets. We typically source transactions from sponsors, getting involved at an early stage, and that means we have around 12 months visibility over our dealflow. For example, we are currently structuring 10 deals for senior, the same for junior, and have already sourced 50 percent to 60 percent of our 2021 transactions. When covid-19 struck in March last year, therefore, that pipeline didn’t just disappear.

That said, I do think there were banks that had to focus on other lending activities in the very short term. I also think that some asset managers, with fewer resources, had to shift their attention away from new investments and towards covid-19 monitoring. Portfolio management was key for us as well and we were proactive. But the size of our team meant that in addition to intensive monitoring of existing assets, we could not only execute transactions in progress but source new ones too. We also found that we were in an even stronger negotiating position as a result of there being less competition in the market. The pandemic continues to be a terrible situation, but for this asset class, and for us, it has also created opportunities we captured for our investors.

What shifts in terms have you achieved with your improved negotiating position?

Since the corporate spread broadened significantly, and because we structure our investments, we were able to negotiate increased yield for a while for our investors. For example, we negotiated market flex, whereby if the pricings went up, any pre-arranged terms would apply.

Covid-19 has highlighted the importance of effective covenants, of negotiating appropriate voting rights, of robust structuring, of debt service ratios, and the appropriate sizing of reserve accounts. All these things have been tested and have been shown to have a crucial role to play in providing a cushion to resist the effects of a crisis, such as covid-19. Because many of the project sponsors we work with are financial sponsors backed by institutions themselves, they understand where specific requests we had were coming from. As a result, we have been able to strengthen the structure of our investments.

How has the asset class stood up to the covid-19 test, generally, in terms of its financial and operational performance?

Broadly speaking, the asset class has come out of the pandemic with its claims of resilience intact. Of course, not all sectors have performed equally. We have never really invested in toll roads with no proven ramp up because we know there is volatility, and the risk might not be rewarded appropriately. And because there has been a lot of liquidity chasing those assets, those deals haven’t always been structured with the type of protections we would want to see. Equally, we didn’t go into airports, not because we don’t like airports, but because we felt the way those deals were being priced didn’t reflect the risks. Nonetheless, overall, I think investors recognise that the way this asset class is structured and documented means we have control over our destiny and that these investments should fare well over time.

What types of investment are you most excited by as we head into 2021?

We invest across all sectors. For us that is key, because even when the market is strong, asset managers need to be able to go wherever the best risk/reward profile can be found at that particular time.

Over the next year, I expect that digital infrastructure will remain strong, as will renewable energy as part of the energy transition. Several of the deals we are currently structuring are in that renewables space. I also think there will be some attractive social infrastructure deals we can close. Healthcare and educational assets have offered premium lately, probably because some may carry added complexity. That doesn’t mean taking more risk. But you may have to work harder on mitigating the risk satisfactorily.

“Broadly speaking, the asset class has come out of the pandemic with its claims of resilience intact”

Meanwhile, we may see transportation dealflow come back; the effects of the crisis could lead to some consolidation and there may be some acquisition and refinancing opportunities. There are transportation assets out there that have been hit hard by covid-19 but are fundamentally strong businesses over the medium to long-term.

In terms of geography, we started out focused on Europe but we are actually looking to become more global. We will be paying attention to the Americas and parts of Asia. As always, we will be looking for countries with a strong regulatory framework. In Europe, we generally invest in countries that are investment grade. But we consider everything on a case-by-case basis. You can always mitigate, or credit enhance risk to get the underlying asset in line with the credit profile that investors expect.

How competitive is the market, particularly in those hot digital and renewables sectors?

Of course, there is competition, and to a certain degree, we don’t mind that. There is between €40 billion and €50 billion of debt issued every year in Europe alone. So, if we were to raise €1.5 billion a year, you are still only talking about 2 to 3 percent of the addressable market, which means we can be highly selective.

Furthermore, there is a difference between competitors with an appetite to invest and those with the depth of resource and expertise to really be able to execute on a significant number of transactions. It takes time to structure these deals properly and I think sponsors recognise that there are sophisticated asset managers out there that can really act as alternative arrangers of debt.

How has the industry evolved regarding ESG and do you think that covid-19 will have an impact there?

When people talk about covid-19 shining a spotlight on ESG, to be honest, I don’t always see the link. Of course, covid-19 has affected society, and governments will probably launch infrastructure programmes to boost the economy, but ESG considerations have been of crucial importance for infrastructure – well, for us anyway – for a very long time.

Indeed, in many ways, ESG is inherent in what we do. I remember stopping work on projects in Indonesia because of concerns over protected species of monkeys as far back as the nineties. When you finance the real economy, when you focus on governance and the welfare of society, when you back assets that reduce CO2 emissions and slow down global warming, by definition, you have an ESG strategy.

That said, clearly, ESG is evolving. It has certainly become a high priority for investors. There is still no agreed standard but there are developments taking place all the time. Taxonomy, for example, will be kicking off very soon. We believe the work that we have been doing over the past three or four years – in particular, integrating ESG into the way we structure, monitor and report – will stand us in good stead as those developments continue.

How would you describe LP appetite for infrastructure debt more generally?

We are seeing investors wanting to commit very large sums of money and that interest appears to be recurrent. Certainly, we see a lot of investors wanting to come in from one vintage to another. We also observe more interest from private investors, and I think we may see a shift in the balance of appetite between equity and debt.

The equity market has become increasingly crowded while the need on the debt side remains huge. On average, assets are financed with around 20 percent equity and 80 percent debt. But, if you look at the fundraising market over the past five years, around 70 percent of capital has gone into private equity funds. I think there is a rebalancing that shall take place, which we are ready to capture.

Broken window repair

You mentioned that governments typically look to stimulate growth with infrastructure spending plans when there has been an economic shock. What role do you think government policy will play in infrastructure debt deal activity in the months ahead?

I am not an economist, but certainly governments have historically sought to boost economies with new infrastructure in times of crisis. There is a recurrent need here, irrespective of the current situation. Whether that is to support the energy transition, to expand digital infrastructure, to boost green mobility or to modernise utilities, pandemic or no pandemic, there is a fundamental need to develop these assets.

So, yes, I think governments are formulating these plans. There are some that have already been announced. But there is a lag between plans being implemented and validated and the projects being tendered, and then the assets being ready for investment on the debt side. So, we are not relying on such programmes to deploy.

We are in constant talks with government bodies and have a clear view on what is likely to be launched, but we are not going to wait for government recovery plans to come into play and invest commitments from investors. The market remains huge and recurrent for infrastructure debt managers.