This article is sponsored by Brookfield, Crédit Agricole CIB, Patrizia and Schroders.
Covid-19 has thrown up unique challenges for infrastructure debt. Two years ago, as airports shut down and teleconferencing emerged as a surprisingly able substitute for business travel, infrastructure debt managers – particularly those with exposure to transport assets – were staring disaster in the face.
But in fact, the asset class rebounded strongly from the initial shock of the pandemic, and now appears poised to hit new heights in the years ahead. The industry leaders who participated in our latest roundtable are unanimous that infrastructure debt has a bright future, despite lingering challenges from covid and the uncertain global macroeconomic outlook.
“The sector has been crash-tested by the pandemic, and it’s been incredibly resilient,” says Matthew Norman, global head of infrastructure at Crédit Agricole CIB. “A dislocation in markets has enabled a number of big transactions to occur – in 2021 we saw a huge uplift in public-to-private deals, particularly in Europe.
“Not only is the supply of capital in good shape, but there’s also a great opportunity for new transactions to come forward as well. There’s momentum, with assets coming to market, whether it be new build or through M&A.”
“Not only is the supply of capital in good shape, but there’s also a great opportunity for new transactions to come forward, as well”
Crédit Agricole CIB
Ian Simes, managing director at Brookfield, agrees that the asset class presents an attractive option to suppliers of capital in the present circumstances. “What you’re getting in terms of superior risks and superior returns makes infra debt very attractive,” he says. “LPs and investors are looking for yield, looking for places to allocate capital to earn attractive returns – there’s a lot of money that’s been printed and that needs to find a home, and more LPs are allocating to the space.”
The rise in appetite for infrastructure debt is, of course, occurring in the context of the wider boom in private markets. “Infra debt as a whole is surfing the private asset secular trend,” says Jérôme Neyroud, head of infrastructure debt at Schroders. “We see a big shift from listed equities and fixed income to private assets and ETF – that’s a very long-term trend.
“Three or four or five years ago, people were asking whether infra debt, or institutional infra debt, would stay the course and would become a real asset class. We aren’t hearing this question anymore. The asset class is here and it’s here to stay – there’s no longer any debate about that.”
As infrastructure debt has grown and matured as an asset class, the barriers to entry for new players seeking to enter the sector appear to have become higher.
“If you don’t have a track record, if you don’t have a team of experienced people, if you can’t point to 10, 15, 20 years in the market, the barriers are beginning to come up,” warns Alex Waller, head of infrastructure debt at Patrizia. “If you’re a new name in the market and you don’t have a specific infrastructure debt track record, I think it’s going to get harder and harder. The door hasn’t closed yet, but it will start to close to new entrants following broad strategies.”
“The asset class is here and it’s here to stay – there’s no longer any debate about that”
It seems that a new entrant tempted to pursue a broad strategy in infrastructure debt may be greeted with scepticism, even if they can draw attention to successes with other asset classes.
But for those new entrants that are prepared to work hard to find a niche, Neyroud emphasises that continuously changing market conditions will result in opportunities that skilled managers could exploit. “Incumbents have a competitive advantage in today’s market, and they’ll keep this advantage if the market doesn’t move. But we all know the market is moving and will continue to move, either because of market forces or because new entrants will disrupt it.”
“As an incumbent,” Neyroud adds, “you have to be very cautious not to rest on your laurels.”
He notes that the relatively rapid rise of junior debt strategies in the past five years demonstrates that there is space for innovative newcomers to disrupt the market. “Will the market change again?” he asks. “Will it segment? Will it evolve? It’s quite difficult to say. When you’re an incumbent, you are always in the middle of your area and you need to keep your competitive edge.”
Waller sees the issue through a similar lens. “Our market is still a challenger market,” he says. “I think everyone, even the incumbents, are still dynamic and are all trying to raise new money and invest it.”
Is it really infra?
Much debate surrounds the question of whether certain assets in the energy transition arena are truly suitable for infrastructure investors.
“If you look at something like EV charging right now, you’ve got to ask yourself the question as to whether that market is proven enough to be classified as an infrastructure investment, with the necessary core defensive characteristics,” says Crédit Agricole’s Matthew Norman.
“Is the business model there, with stable revenues? That’s a tricky one. It does fit within a strategy – perhaps a higher-yielding energy transition strategy, a high-growth strategy, a higher-return strategy. But it seems less well suited, at this stage, to fit into a core infrastructure strategy.”
Junior debt seizes the moment
Crédit Agricole’s Norman specifically cautions that a new entrant trying to raise a senior debt fund would be “competing with monsters sitting there who have a proven track record”. Noting that the BB and BB+ space has become overcrowded, he adds that “to find a niche, to reinvent oneself, rather than sitting there with a global infra debt offering, is going to be critical”. Some managers may need to “go further down the credit curve” in order to differentiate themselves, Norman concludes.
While concurring that new entrants face formidable obstacles in competing with more established players, Simes argues that opportunities will emerge, particularly for managers that pursue high-yielding strategies. “The higher-yielding end of infra debt has traditionally been a very niche part of the sector. It’s still niche, but it’s growing faster than the broader infra sector,” he says. “Because the niche part of the market is growing more quickly, that provides room for incumbents to grow and room for new entrants.”
Simes describes the growing popularity of junior debt strategies as “a natural maturing of the space”. He says that as the market for infra debt developed, “we started to see differentiated offerings and greater specialisation as there were more entrants to the sector. It feels like a natural evolution, both from the demand side and also on the supply side from investors.”
Neyroud agrees that “it’s pretty much natural that we are moving into something that is a little bit more segmented, a little bit more sophisticated, a little bit more optimised”. He points out that junior debt was pioneered by managers who responded to demands from clients to “do something more effective from a return perspective, while still retaining the defensive characteristic of infrastructure”.
Junior debt plays appear to be adding sophistication, with managers employing a range of tactics within the space. “There’s more than one way to skin a cat and there is probably more than one way to do a junior debt product,” Neyroud says.
He adds that within junior debt strategies there are “two different subsets and we may well be at the eve of a new segmentation within the segmentation itself”.
“The lower-return, lower-risk part of junior debt is essentially proxy to high-yield debt for investors, but it’s still debt, which means it’s an income product, where you would get your money back and get a nice return of 5 or 6 percent,” says Neyroud. “If you look at the other side of the spectrum, there is a different relative value proposition and something which may well be closer to equity. One would forgo the operational value that is being created by equity, but would play a financing arbitrage.”
Waller expands on the linkages between junior debt and equity investing. “Senior debt is one bridgehead to junior debt investing; equity is the other,” he says. “When we talk to investors, we tell them that they can get a lot of what they like about equity with a very different risk profile.”
Consolidation conspicuous by its absence
Our panellists agreed that the infra debt market is maturing and that the barriers to entry for firms pursuing broad strategies are rising.
Patrizia’s Alex Waller notes that infra debt investing is increasingly the preserve of managers capable of raising large funds. “Being a $4 billion or $5 billion manager seven or eight years ago was fine, you had substance and could be competitive,” he says. “Now, that is a small manager.”
But, says Waller, this trend does not appear to be translating into genuine consolidation in the infra debt market. “M&A activity within the infrastructure space is really a function of big infrastructure-less asset managers wanting to expand into private infrastructure asset management and buying in that capability, rather than growing organically.”
Ian Simes of Brookfield agrees. “I can’t think of an example where there are fewer managers because of an M&A transaction amongst managers,” he says. “We’re not seeing that type of consolidation – and I don’t think we will for some time yet.”
Green and digital assets
The optimistic outlook for infrastructure debt owes much to the need for vast investment in infrastructure for both the energy transition and the digital revolution. Norman is particularly enthusiastic about the prospects for fibre-optic infrastructure. “Fibre rollout from our perspective is driving huge volume in the market, given the once-in-a-generation need for network rollout,” he says. “The demand for capital in this sector is staggering and there’s a really interesting opportunity there for institutions and banks to play. The sector offers an attractive yield pick-up for participants in the market.”
Meanwhile, he notes that issuers are “focused on rapid rollout, in order to secure first-mover commercial advantage, and as a result they’re prepared to pay to get invested early. We see this trend carrying on for the next three or four years”.
Simes agrees that the growth of the fibre network will bring major opportunities for investors. However, he cautions that “jurisdictions have very different risk profiles” for fibre-to-the-home. He praises the French market as “well structured, logical, easy to understand” in comparison with Germany and the UK. In Spain, meanwhile, Simes notes that “the costs of rollout are substantially lower, so the defensive position is quite different”.
“Senior debt is one bridgehead to junior debt investing; equity is the other”
“That’s something to be mindful of when thinking about infra – if somebody else can roll out similar fibre to you at a very low cost, it’s not as defensive as it might be in other jurisdictions.”
While the energy transition certainly creates opportunities, our panellists were less enthusiastic about investing in core renewable energy assets. “Renewables are rather overbid at the moment,” says Waller. “Our pipelines are often 50 percent full of renewable deals, but many of those transactions don’t happen, because we’re not the lowest marginal cost provider of financing to Western European renewables borrowers.”
Norman offers a similar view, noting that “renewables have got to the point, certainly in Western Europe, where it’s very difficult for investors to get deployed in that sector. Banks are very aggressive there. In many cases it looks too tight from a relative value perspective to get invested in Western Europe”.
Outside of renewables, Norman cites opportunities in smart metres, battery storage and energy-from-waste projects, although he concedes that “the deals are usually smaller” for these assets. “The challenge on the energy transition is finding sizeable opportunities to put money to work.”
Waller agrees. “One important consideration, in the infrastructure debt world, is the ability to write significant cheques,” he says. “Some of the borrowers in these start-up, newer sectors are possibly better off relying on straight equity, rather than trying to accommodate the kind of debt we provide. Once their business has matured, maybe three or four years from now, they can come back to people like us and consider employing a more complex capital structure.”
When it comes to hydrogen-based technologies, their suitability for infrastructure investing is a controversial topic – and Jérôme Neyroud from Schroders Capital is in no rush to write cheques for hydrogen projects.
“We’ve had some surreal conversations,” he tells us, “where an adviser is knocking at our door and saying, ‘Look, I’ve got a wonderful hydrogen project.’ We ask what’s the technology, and they say, ‘Well, it’s brand new, it’s exciting, it’s a prototype.’ In reality, the technology is unproven and they have no market to sell to. In lenders’ terms, that means it’s not bankable. There is no business model behind it.
“We are not venture capitalists, we are lenders, and there are limits to what we can do and what we should do. Maybe in a few years, hydrogen projects will have a business model and proven technology, and we will be more than happy to lend to those projects or companies. But the ESG flag cannot solve any and all credit problems.”
“The best measure for us is whether we are creating better value than other credit alternatives that investors can invest in”
Brookfield’s Ian Simes is somewhat more sanguine about hydrogen, noting that a future rollout of hydrogen projects to replace natural gas infrastructure would create vast investment opportunities. While he agrees that “it may be too early to consider some technologies as core infra yet,” Simes reminds us that offshore wind overcame the sceptics who only 10 years ago considered wind assets to be too risky.
Facing down macro risks
Infrastructure debt has enjoyed the luxury of a boom in private markets. As we head further into 2022, however, macroeconomic headwinds are strengthening, at the same time as political, regulatory and technological pressures raise questions for asset managers. The challenges will be complex.
One obvious risk facing the asset class is inflation. Our panel, however, is confident that infra debt will ride out any worsening in the inflationary situation. Even in a worst-case scenario where inflation starts to erode returns for investors, Simes expects any dent to infra debt’s reputation to be limited, relative to other asset classes. “We think the best measure for us is whether we are creating better value than other credit alternatives that investors can invest in,” he says.
“Even if you may think that the underlying return is not good enough in a high-inflation environment, the same problem applies to all credit investment options that are available to investors. The key for us is that we remain a relatively attractive credit investment for investors through low- and high-inflation environments.”
Meet the panel
Head of infrastructure debt, Schroders
Jerome Neyroud has dedicated the past 25 years to advising on, structuring and investing into hundreds of debt investments totalling more than €50 billion in the EMEA region across all infrastructure sectors. He has been building and heading Schroders’ infrastructure debt practice since inception in 2015.
Global head of infrastructure, Crédit Agricole CIB
Matthew Norman has over 20 years of infrastructure and energy industry experience. Before joining Crédit Agricole CIB, he worked in the investment banking and wealth management divisions at Indosuez. He was appointed global head of infrastructure in 2016.
Managing director, Brookfield
Ian Simes is a managing partner in Brookfield’s Infrastructure Group and co-head of its infrastructure debt business. He oversees the origination, execution and asset management of the firm’s infrastructure credit investments in Europe and Asia-Pacific. Previously, he was a director on the infrastructure team of the capital markets group at Citigroup.
Head of infrastructure debt, Patrizia
Alex Waller is a senior managing director at Patrizia, leading its infrastructure debt investing activities. He has overseen investments across a broad range of sectors and geographies, and led the successful inaugural European infrastructure debt fundraising of over €500 million. He joined the firm in 2007.