“In terms of low yield and too much liquidity chasing the same yield? Yes, absolutely,” Claus Fintzen, chief investment officer and head of infrastructure debt at Allianz Global Investors replies when asked whether infrastructure debt has turned ‘frothy’ in certain markets. His response echoes that of all the other professionals Infrastructure Investor interviewed for this article, although not everyone agreed in what way that frothiness has manifested.
Alexander Waller, head of infrastructure debt at Whitehelm Capital, for example, believes that frothiness is mostly on the pricing of transactions and not necessarily on risk.
“I think the infrastructure financing market has generally kept its head over the last few years, kept its discipline,” Waller remarks. “We haven’t seen covenants removed from documentation; we haven’t seen lock-ups being dropped.”
Ian Simes, Brookfield’s senior vice-president, infrastructure group, agrees that “there is some frothiness without a doubt,” not only in terms of pricing, but also in a weakening of terms and conditions. However, “there has been reasonable discipline around the quantity of debt in this credit cycle, as we found central banks and regulators very focused on keeping the risk of the whole sector under control,” he points out. “Ten years ago, leverage just kept going up as values went up, whereas now leverage is reasonably static as valuations rise, reflecting that discipline to investment-grade metrics in senior debt. I think that’s one key differentiator from the frothiness we saw 10 years ago.”
According to a March update by Schroders, spreads have held steady at 2 percent in the European core, five- to 10-year market, while the high-yield market can earn spreads of more than 4 percent. However, in the up to 30-year sector of the market, excess demand has pushed up prices and lowered credit spreads to between 1.5 percent and 2 percent. “Although these assets continue to serve a purpose from a liability-matching standpoint, they now offer far less appeal on a standalone basis,” Schroders concluded.
However, this frothiness has not dampened investors’ appetite for the asset class. Rather than looking for a way out, fund managers and their clients are seeking paths to navigate the infrastructure debt space accordingly. That could mean venturing into junior/mezzanine debt or adjusting their senior debt strategy.
Schroders, for example, covers the full spectrum of instruments in the infrastructure market, from senior debt to equity to junior debt.
“The reason why we have the full spectrum of products is because our aim is to offer investors access to these markets whatever their objectives and constraints may be,” explains Charles Dupont, head of infrastructure finance.
“When we launched our platform in 2015, we had strong demand from investors to offer senior debt, but since we’ve been growing, demand has diversified.”
AllianzGI has also made adjustments to its strategy. Until now and since the firm launched its infrastructure debt platform in 2012, the focus has been on senior debt. “We started originating deals in traditional PPPs or PFIs and at some point more and more investors started focusing on this sector and we could see that the financing terms became borderline investment grade,” Fintzen remarks. A similar situation followed with gas and electricity transmission system operators in Europe.
Its response to increasing competition – which Fintzen describes as “a constant threat” – is Allianz Resilient Credit, a shorter-term strategy that has a weighted average life of seven to eight years with more of a total return aspect to it.
“The idea is that we do secured senior debt on slightly less essential infrastructure assets – some would call it core plus, we call it resilient – because the cashflow is still resilient,” Fintzen comments. “But we can invest in mezzanine/junior debt on core infrastructure assets.”
Fintzen offers Scandinavian regulated utilities as an example, which were bought by infrastructure equity funds and subsequently refinanced. “They have some junior debt in there, which is high leverage, but considering the regulation and related stability, we think they’re interesting.”
For other fund managers, the junior/mezzanine debt space has been the focus from the outset.
Andrew Jones, global head of infrastructure debt at AMP Capital, has been focusing on subordinate debt for the past 18 years.
“The rationale for that has been that we found – and this has been consistent over a number of cycles – that there are more attractive returns available for investors in the junior or mezzanine space relative to other more crowded parts of the capital structure, such as infrastructure equity or senior debt, where there’s more competition from banks,” he explains.
As a result, AMP Capital sees the mezzanine debt segment remaining “relatively uncrowded”.
Similarly, Whitehelm Capital, which is also Australian, has focused on “high-yield infrastructure”, a term the firm uses to distinguish it from mezzanine debt as might be interpreted by a leveraged finance investor.
“For us, it means investing in high-yield core infrastructure debt that is cash-paying, that doesn’t have equity-like features,” Waller notes. “We might be subordinated in the capital structure, but we’re looking for safer, cash-pay, sort of true infrastructure-type returns and assets, without commodity price exposure or other merchant risk.”
Whitehelm has taken this approach for the past 16 years. “We’re very happy where we are in the capital structure at the moment compared with senior debt and also compared with big-ticket equity,” Waller remarks.
For Brookfield, the decision to focus on the junior debt space is due to a combination of reasons.
“The spread compression in the senior debt space has been quite intense and we certainly see better value in the mezzanine space,” Simes says. “But another reason for us to focus on the mezzanine/junior lending area is also due to our background and capability.
“As an equity investor in a number of these projects, we feel that we have a lot of insight into the risks of these assets and since mezzanine debt is riskier than senior debt, being able to draw from that knowledge base as an owner of similar types of assets means we are well placed to assess the risks and deploy capital into this segment,” Simes explains.
“Also, when the markets inevitably turn, we’re well placed to look after a distressed situation having that ownership base; the operating platforms that we have behind us.”
In the past four to five years, when infrastructure debt transitioned from “a peculiar, greenfield project financing activity”, as Schroder’s Dupont puts it, to a full-fledged asset class, the preferred vehicle for accessing it has been the separately managed account. But that view is changing.
“There is no preferred vehicle,” Dupont states unequivocally. “Depending on why you want to invest in infrastructure debt and how much you want to invest makes a difference. One of the reasons why we’ve been able to grow so quickly is because we did not respond to a complex question with a simple answer.”
To date, Schroders has invested in infrastructure through six separate accounts and three debt funds, representing €1.5 billion of investments. It is slated to launch a fourth fund, a new vintage of its Euro Senior Loan strategy, in the near term. The team has expanded its product offering in response to client demand.
For Whitehelm, the decision to consider raising capital via a fund structure is in response to investor demand. To date, the firm has invested in the asset class via separate accounts.
“There are investors out there who won’t invest enough money to warrant the setting up of a formal SMA or where they wouldn’t be able to get sufficient diversification,” Waller explains. “We can bring together those smaller investors [in a fund] and give them the diversification and access to transactions,” he continues.
In addition to developing the right products to meet client demand, Whitehelm prefers raising money in a “measured fashion”. For example, the fund manager is aiming to raise €500 million this year, with a portion likely to come via a fund structure.
“We don’t need to treble in size in two or three years. We’d rather grow a sustainable business, delivering great returns today but also five, 10 years from now and increase capital steadily,” Waller says.
For AMP Capital, which closed its third infrastructure debt fund in July on its $2.5 billion hard-cap – with $1.6 billion raised for co-investments – a robust war chest makes sense. “Offering larger single investments to the sponsors that we work with broadens our opportunity set,” Jones argues. “We already have a series of very attractive investments in our third fund, as well as a very strong pipeline, with a number of those investments up in the $200 million to $300 million range. So, the greater firepower that we got with our third fund is proving effective.”
Asked whether the infrastructure debt market is susceptible to a fast pace of change, the consensus among those interviewed was that volatility is not an issue.
“Our markets have remained pretty stable over the last three or four years, in terms of transaction volumes, in terms of structure and in terms of pricing,” Whitehelm’s Waller states, referring specifically to the high-yield space.
Brookfield’s Simes agrees. “We can track the current cycle from 2010-11 until now with spreads getting tighter every year,” he says. “If I look at the market today, there are a few more providers than there were six months ago increasing the competitive tension in the market, but it’s been a gradual evolution in the same direction for seven-odd years now.”
AMP Capital also hasn’t witnessed any volatility. “The returns that we’ve generated have remained consistent across all of our fund series to date and even today, we’re still achieving the same returns we have achieved historically,” Jones comments, adding that dealflows have also remained consistent.
One of the biggest changes, according to Jones, is the number of new entrants in the infrastructure debt space, particularly senior debt. But while that may have brought increased competition, it has also led to greater investor awareness and a better understanding of the asset class.
“There’s a much larger pool of experienced participants now and the asset class is much better understood,” he says. “And that I think is a great benefit to us all.”