It has become increasingly difficult for institutional investors to find yield in the low-rate environment that has persisted since the global financial crisis. This has led many to infrastructure debt, where incomes are deemed to be more reliable, with lower default risk and potentially better diversification qualities.
There have been a significant number of big launches by some of the industry’s biggest names in recent years, thereby demonstrating the strength of appetite for the asset class. The most recent was the $1.7 billion closing this year of BlackRock Real Assets’ Global Infrastructure Debt Fund, much of which was raised during the pandemic. The 2021 Schroders Institutional Investor Study showed that this appetite remains strong, with 18 percent of allocators looking to increase their infrastructure debt holdings over the following 12 months.
Not just about yield
Alexander Waller, head of infrastructure debt at Whitehelm Capital, says yield is a significant component of the asset class’s attractiveness. He adds that there are a wide range of infrastructure bonds to meet investors’ different needs. “At the lowest end of the risk spectrum, investors are looking to make a small premium over very richly priced liquid markets,” he says. “Higher up the risk spectrum, headline yields may be similar to other credit asset classes’, such as leveraged loans and high-yield bonds.
“But infrastructure debt is expected to deliver superior credit performance – ie, fewer defaults and higher recoveries – and this has been borne out by experience over the past 15 years.”
The multi-faceted nature of infrastructure debt means that, if it is used correctly, it can serve a number of functions within investors’ portfolios. Sundeep Vyas, head of infrastructure debt, Europe, at DWS, explains how the asset class has many key attributes, such as “diversification, duration, credit resilience, inflation hedging and also ESG/impact characteristics”.
These ESG/impact characteristics overlap with some of the major themes impacting most asset classes. With aged infrastructure increasingly being revamped or replaced, there is scope for debt investors in new projects to gain exposure to longer-term trends.
“Specific to infrastructure assets, growth has been driven by long-term markets trends such as energy transition and digitalisation,” says Karen Azoulay, head of infrastructure debt at BNP Asset Management. “The trend favouring renewables continues to gather momentum, creating huge infrastructure needs in the upcoming years.
“Energy transition also relates to the decarbonisation of sectors such as utilities and transportation. Large amounts of investment are needed to support the phase-out from a carbon-intensive energy mix to low-impact energy production, including hydrogen in particular.”
She adds that the need for data and connectivity in an increasingly digitised world is likely to lead to other opportunities with more investment in optical fibre networks and data centres: “Digitalisation should allow infrastructure assets to be more efficient with the deployment and usage of smart grids or smart meters.”
Not all institutional investors are looking for the same type of infrastructure debt, however. Senior infrastructure debt tends to find favour among liability-matching investors such as insurers and defined-benefit pension funds. DWS’s Vyas says such demand is typically greater among those looking to gain initial exposure to the asset class or driven by duration or regulatory requirements.
“Infrastructure debt is expected to deliver superior credit performance… and this has been borne out by experience over the past 15 years”
“Insurance companies have allocated large amounts of capital to many senior debt funds driven by Solvency II capital requirements, which ensure a preferable capital treatment to senior debt investments to infrastructure projects and corporates,” he says.
Meanwhile, junior debt appeals to less-constrained investors – such as other kinds of pensions, sovereign wealth funds and family offices – that are increasingly looking for more complex types of securities, such as stretch senior/unitranche, junior or mezzanine debt. “Demand for junior debt is growing from those investors already familiar with the asset class and looking for higher-yielding products,” adds BNP Paribas’s Azoulay. “They are usually looking to diversify their alternatives portfolios with assets with a more defensive risk profile that still offer attractive relative value.”
Safe as… infrastructure?
Infrastructure debt is often seen as a safer investment than other private debt asset classes, says DWS’s Vyas, having proven itself to be “very resilient” over several credit cycles. This reputation has been strengthened during the pandemic. “While in some cases infrastructure assets have faced dividend freeze or recapitalisation, infrastructure debt has generally continued to perform well,” he says.
However, Whitehelm’s Waller says the impact of covid on infrastructure debt was limited mainly to transport-linked assets and those dependent on footfall. “A real test will be an enduring period of volatility with rising rates and rising inflation,” he says. “It will be interesting to see how certain strategies – fixed rate and mezzanine in particular – stand up against this pressure.”
Nevertheless, Vyas says investors should practise – or choose a manager that specialises in – disciplined asset selection and robust debt structures to make sure their investments remain resilient and achieve expected returns, even during a crisis.
Winners and losers
Despite the successful closure of BlackRock’s debt fund, some have warned that the continued popularity of the asset class could create a crowded space. Although more liquidity is coming into the market and the deal pipeline is robust, BNP Paribas’s Azoulay says the number of players in the space “falls short” of the infrastructure equity market.
“The infrastructure debt market in Europe and North America has developed considerably over the past 20 years,” she says. “Banks have progressively and continuously reduced their presence – at least for long-term maturities – due to regulatory constraints, with institutional investors and funds stepping in to provide senior and subordinated financing.
“The market is very deep. With deals totalling $105 billion in 2020, we are confident that there is ample space for more players to participate in the asset class.”
Azoulay adds that “very substantial capex” will be needed to support the significant growth in infrastructure sub-sectors that support the digitalisation of the economy and in which new and greener assets are required to meet net-zero targets.
“Of course, there will be winners and losers,” she says. “As the market continues to deepen and broaden, investment expertise will be key to selecting the right themes, assets, projects and therefore credit.”