Australian fund manager IFM Investors has launched a new open-ended infrastructure debt fund that is targeting investments mostly in the US and has raised around $500 million to date. The debt fund has made two investments in midstream projects and is targeting more assets for sub-investment grade transactions.
IFM Investors, which is owned by 27 Australian pensions, already manages $5 billion of infrastructure debt investments globally – a third of which are located in the US. As IFM Investors targets its next deal, Rich Randall, the firm’s global head of debt investments, explains to Infrastructure Investor the benefits of debt investments over equity.
What is infrastructure debt and how does a transaction work?
RR: Infrastructure debt is typically a senior-secured, first lien debt instrument that has a security interest in an infrastructure project with high-value barriers to entry, a known revenue stream throughout its lifespan and is important to society. What that means for investors in infrastructure debt is a very low probability of loss.
Most infrastructure projects are capitalised with between 20 and 40 percent equity. The remainder comes from the debt markets. An equity owner will develop or purchase an asset and will come to us to help capitalize it. They’ll put in the 20-40 percent equity, and then we’ll come in with a senior-secured debt position. These projects are usually so large, we can’t provide all of the debt for a single project, so we operate with a consortium of other lenders.
Why should someone commit capital to an infrastructure debt fund instead of an equity fund?
RR: Institutional investors usually divide assets into two buckets: fixed income, which is very liquid, and alternatives, when they’re looking for less liquid investments that are much higher yielding. Infrastructure debt can fit into both because it tends to be a little higher yielding. However, even though it’s a fixed-income debt product, it’s generally not listed and therefore less liquid.
A lot of conversations we have with our investors are about where it should sit within their asset allocation. It kind of straddles the two. For an investor comparing infrastructure debt to infrastructure equity, the primary difference is the relative risk they are trying to achieve and the liquidity required, which is quarterly for the infrastructure debt fund managed by IFM Investors.
What can an investment in infrastructure debt bring to an LP’s portfolio that equity can’t?
RR: Infrastructure debt tends to have a very low probability of loss compared to equity. That’s probably the most important [factor], given the late-stage credit cycle we’re in now.
It also tends to provide return as a current yield, which is basically paying a cash coupon, as you’d expect of a debt instrument. We get a fixed-rate return, a combination of interest and principle. For LPs, that provides a layer of liquidity.
Do macroeconomic factors affect infrastructure debt investments and equity investments in the same way?
RR: To some extent, yes. From time to time, there is too much capital chasing too few deals, which is also common in the infrastructure equity market. What happens in the debt market, however, is that capital has a higher velocity to it. If there’s excess infrastructure debt capital, that capital will quickly move to another part of the debt market. It’s much more portable. We’ll see people more quickly reallocate from a certain part of the debt market – the corporate debt market, for example – into a private debt market.
What is IFM’s strategy regarding infrastructure debt investments?
RR: Our business is split into two components: investment grade and sub-investment grade. Investment grade is what you call in infrastructure equity language core-type investing: long-life assets with fixed revenue streams through contracts, PPAs or government availability payments. It is known as a safer asset class and is lower yielding as a result, which is attractive to our insurance company clients around the world.
The other piece is the sub-investment grade space. Sub-investment grade investments have less long-term visibility on the revenue stream. For example, a project with a 20-year asset life would have a seven or 10-year contract, which means there is more merchant or commodity risk later on. In exchange for that risk, you get more equity in the transaction, which compensates for the risk of less long-term visibility of the revenue stream, helping it remain an attractive investment with a higher return potential.