Were it not for all the equipment being readied for our photo shoot, Deborah Zurkow’s office would look astonishingly tidy. There is a reason for it: Allianz Global Investors’ head of alternatives has just moved in; otherwise, an elaborate tower of folders and memos would adorn it, she says.
Building structures from the ground up is something Zurkow and her team have historically been pretty good at. In 2012, when the crew first got together to lead AllianzGI’s infrastructure debt efforts, regulators, central authorities and investors had little time for infrastructure, she recalls. “But today, when you open a newspaper, people don’t ask, ‘Is infrastructure an asset class’? They say, ‘the infrastructure asset class’. So, over a relatively short period of time, infrastructure has gone from something that institutional investors didn’t see much of, to being something they assume should be part of their portfolios.”
This is particularly true of infrastructure debt, an area that was not on institutional investors’ radars four years ago, but in which AllianzGI has since deployed more than £7 billion ($9 billion; €8 billion). The firm sees itself as instrumental in developing the market, a claim that is hard to dispute.
Seeds were first planted in 2004, when five of the unit’s current members brought their heads together to analyse the infrastructure debt market and understand its potential for private capital. Formerly chief executive of Trifinium Advisors, a subsidiary of monoline insurer MBIA, Zurkow became team leader as she joined eight years later and the squad started engaging with regulators straight away. It was a matter of explaining to them that, “in the early phase of the market, it’s more about reducing barriers than putting them up,” Zurkow recalls.
It was also about convincing borrowers that institutions – not banks – could come up with a credible offering, while convincing investors that a strong deal pipeline existed. Europe seemed a promising place to start. “People generally say that in the US, capital markets provide 80 percent of the financing and banks 20 percent. In Europe, in contrast, they say it’s 80 percent banks and 20 percent capital markets. But when we started out, it was probably more like 95 percent banks and 5 percent capital markets,” Zurkow notes.
Other latent factors made the business case rather compelling. Cash-strapped governments were looking for capital to fund growth-boosting infrastructure, regulation-bound banks were pulling back and “quantitative easing was driving all value out of the public markets”, says Adrian Jones, a director of infrastructure debt at the firm. “That’s the one factor that’s moved beyond project finance and infrastructure, touching all pockets of private credit,” he says. Zurkow, now in charge of overseeing said pockets, agrees.
Data soon became a central weapon in the quest to convince regulators – the toughest crowd to win over – Jones observes. “The data was there, but it just was not in a form which was directly accessible; it had to be translated.” Moody’s insights on default and recovery rates proved to be particularly useful, as did aggregation efforts by the Long Term Infrastructure Investors Association, of which AllianzGI is a founding member.
MADE TO MEASURE
Fast-forward a few years and AllianzGI has become one of the dominant players in a healthily growing market. Yet the firm has so far eschewed scale and mega-funds prevalent in other corners of the industry, favouring tailor-made structures and smaller pooled vehicles. Indeed, the €9 billion it currently manages in infrastructure debt is spread across some 45 accounts.
One reason for this is the need to conform to local regulatory constraints at the asset level. “Disparities between different member states’ regulation and tax positions may seem minor from 50,000 feet. But when you’re trying to get a transaction done it can be more than a small bump in the road,” Zurkow says.
“When we first got here we thought, ‘We’re in asset management, so we’ll just do a couple of funds’. But the reality is, if you want your investments to create optimal positioning in the balance sheets of the various investors, you often find that you need to conform to the best vehicles under local regulations, because they need to think about what the tax implications are in different jurisdictions,” she adds, noting that the firm, for instance, manages different vehicles for investors based in Italy, France, Germany and the UK.
Another factor has more to do with clients’ demands. “A number of our investors have gone into infrastructure for the particularities of what their liability-matching needs are. Which means that what they’re looking for may not be the same from one to the other,” says Jones. “There might be one who wants renewables and the other one who doesn’t really like them. There might be one who wants up to 15 years and the other one who only wants over 20. So, actually, the bespoke nature of the investors’ objectives resulted in having a lot of SMAs[separately managed accounts].”
“When you’re talking about how you help to construct a market or support market expansion, you actually need the smaller investors as well. Because you don’t want to have a market that can become fragile through the departure of an elephant,” adds Zurkow. “Bringing in the smaller investors was important to us, not only from an investment objective, but also actually from a market stability point of view. Of course, we’re looking for more opportunity for ourselves, but larger growing markets are clearly good for everybody.”
To some extent, AllianzGI’s view is not so different from that of a start-up – seeking to shape a market segment rather than stealing business away from entrenched competitors. “We’ve never thought of it in terms of market share,” Jones sums up.
BEATING THE BENCHMARK
Listening to the architects of the firm’s core infrastructure debt strategy, it seems the initial bet has paid off rather well. Infrastructure debt is a “margins business”, Jones explains, where one can expect to reap 100 basis points above the risk-free rate for a core asset. “We’ve consistently outperformed the index we use. All our investments are at a premium to utility bonds, which is what somebody with a fixed income allocation would invest in if they’re looking for triple-B, stable,15-year cashflows,” he says, adding that his team uses spread indices from Bloomberg.
The margin, he argues, is a reward for “good, old-fashioned efforts” in securing commitments from investors and borrowers, especially when the deal involves construction risk. It also captures a liquidity premium, though Zurkow has issues with the way infrastructure debt’s illiquidity risk is generally construed.
“Investors in this market are buy-and-hold and there’s a substantial increase in the number of investors. Now there’s actually more buyers than sellers. I think all the portfolios we have we could easily sell today. So I would argue that liquidity is held back not only by the nature of the investments but also by the nature of the investors,” she says, noting that even a listed infrastructure company would be faced with liquidity problems – or at least pricing issues – should it face a significant bump in the road.
However, solid performance in the past is no guarantee about the future – especially when the market catches up with you. At first, the debt team made its name by presenting itself as an arranger of large-scale European greenfield PPPs, providing hundreds of millions to finance the likes of German and Scottish roads.
“Across our markets, people used to say institutional investors will never accept taking construction risk,” Zurkow notes. “If you ask a lot of people in the markets today if investors would take construction risk, I’d be shocked if there was anybody who said no.”
As once-sparse segments started to become more populated, however, AllianzGI thought it necessary to expand its horizon. Having made its first euro-denominated and sterling investments in 2012 and 2013 respectively, it then set up shop in the US, sealing its debut dollar transaction in 2015. New entrants on its hunting ground then prompted it to widen its focus.
“First-mover advantage doesn’t last very long. Initially we were a little bit ahead and alone but then the market got so crowded that we decided the value proposition wasn’t as good as we thought. We started doing more M&A transactions, where we’ve provided longer-dated debt than the banking market did. And lately we’ve seen a lot more refinancings,” Zurkow says. They also turned to fixing things that “were not put together too well” prior to the crisis, adds Jones.
That all stayed under AllianzGI’s long-dated, core infrastructure umbrella. But last month the firm launched a distinct unit, designed to marshal a new strategy: medium-term, credit-secured infrastructure debt. “We’ll be doing senior debt for assets for which we couldn’t lend for 30 years but we’ll be happy to do for 10 to 12 years,” Jones explains.
There will also be opportunities at the holding company level, as well as room for mezzanine, “which on the risk spectrum sits between core senior debt and equity,” he adds. “We’re now looking across the capital structure for the right maturities at a broader range of assets.”
It made sense to launch a separate unit, the team explains, even though they could have kept it under the same banner. “Thematically, it’s exactly the same”, Zurkow says, as the strategy’s prime objective is to deliver stable cashflows. Hence its name: “Resilient Credit”.
But it was necessary to make it a new business, she adds, so as to “keep to a very clean definition of what we do”. “That also has to do with the responsibility of developing the market. The first time investors are surprised by what they’ve got, the market’s going to get jittery.”
So what sort of assets will Resilient Credit be looking at? “It’s any business that is asset-heavy, has good gross margins and credible reasons why revenue will be stable over the term of the debt,” Jones says. Can he elaborate? “If we’re talking core infrastructure, 30-year debt, you’re in the regulated space. If it’s 10 years, you’re talking about market power and barriers to entry. Examples would be certain assets in the energy generation sector, depending on counterparties.” The strategy, typically, will be aiming for 50 to 200 basis points above core senior debt.
AllianzGI is already present higher up the capital stack: the firm’s infrastructure equity team launched its first renewable energy fund at the end of 2012, closing it on €150 million in September 2013. Its successor closed on €350 million last November, and the unit now manages €1.2 billion, the balance being accounted for by a segregated account. Smaller in scale than its debt cousin, AllianzGI’s infrastructure equity business also has a narrower focus, since it solely invests in renewable energy. Which is not surprising – a handful of its key members, including head of investment strategy Martin Ewald, come from Allianz Climate Solutions, the parent group’s renewables insurance and advisory division.
His definition of the team’s mission is straightforward: “What we do is essentially to perform the transmission of an equity interest of a real asset into what’s required for institutional investors, those who can’t or don’t want to run their own teams in the infrastructure equity sector in Europe.”
The benchmarks the equity team members use differ from those of their debt colleagues, as equity performance is mostly assessed in IRR terms. Operational assets in the renewables sector, Ewald says, tend to command returns of between 4 and 6 percent. If you start adding construction risk, it’s reasonable to expect another 300 basis points.
Is the team on target, then? Assets that have recently become operational, Ewald responds, currently return about 5 percent, but older assets that the firm still holds typically generate another 100 basis points, as the market was less liquid when the firm initially bought them.
Zurkow is keen to emphasise that AllianzGI has taken a prudent approach to raising capital across all strategies. “We’ve actually constrained our fundraising. We’ve wanted to make sure we didn’t end up with an underspend relative to investor expectations.”
That’s also because AllianzGI’s LP universe remains fragmented, with property insurance companies wanting different things than life insurers, and defined-benefit pensions having other constraints than their defined-contribution counterparts. The advantage of having all strategies under one umbrella, Jones comments, is that comparative value becomes apparent.
“We’re realistic enough to know that we can’t force projects to come to market at the right price,” he says, to illustrate the team’s emphasis on investment discipline.
Could interest rate rises, following last month’s Fed hike, threaten the entire enterprise? The team does not think so. “We’ve got a really diversified source of strategies. So when you look at the leverage loan business or anything that’s on a floating rate basis, of course, the rates going up isn’t a bad thing,” Zurkow observes. “Any theoretical loss on the assets,” Jones adds, “is more than offset by gains as our clients’ liabilities reduce.”
That diversity, together with its ability to create new strategies like Resilient Credit, should stand AllianzGI in good stead. It also serves as a reminder that, to retain its first-mover advantage, AllianzGI has no choice but to remain nimble on its feet.