Stars are aligning for green infrastructure debt, says Macquarie

This article is sponsored by Macquarie Asset Management

What is driving the growth of the green infrastructure debt market?

Tim Humphrey: To limit the impact of climate change and meet the objectives outlined in the Paris Agreement, the amount invested in renewable energy technologies each year must increase from about $300 billion today to almost $800 billion by 2050, according to the International Renewable Energy Agency (IRENA). We have already started seeing this step-up in investment filtering into the infrastructure debt market, with a large and growing number of renewable energy investment opportunities within our
pipeline.

Based on our analysis, the renewable energy sector currently represents around half of the global infrastructure debt market by volume. The opportunity set has therefore grown to a scale that lends itself to raising a dedicated pool of capital. At the same time, there is growing investor interest in making allocations to green infrastructure debt as they seek greater exposure to more responsible and sustainable assets.

The stars have aligned for the sector, with strong investor demand coinciding with the ability to deploy capital at scale.

What is driving investor interest in green infrastructure debt?

TH: The ESG benefits of green infrastructure debt are naturally a positive feature. However, investors are ultimately drawn to the risk and return characteristics of these investments.

In particular, the sustained low interest rate environment has increased pressure on investors to seek alternatives to their traditional corporate and government bond allocations. Green infrastructure debt is able to deliver additional yield for investors that can accommodate the illiquidity and complexity of these investments.

In addition to yield enhancement, investors are attracted to the strong credit characteristics. When compared with corporate bonds of similar credit ratings, green infrastructure debt has demonstrated a lower probability of default, greater ratings stability, higher recovery rates and lower expected losses.

What do investors look for in a green strategy?

TH: Investors increasingly expect managers to demonstrate that they have robust frameworks in place to quantify the impact of their green investments. This is not always a straightforward process, and the industry is on a journey to enhance classification and reporting standards.

We are fortunate in that Macquarie Group’s acquisition of the Green Investment Bank from the UK Government in 2017 helped to strengthen our approach, enabling us to access a team of experts with well-established reporting practices that offer our investors
a lot of comfort.

We established an Article 9, or ‘dark green’, EU Sustainable Finance Disclosure Regulation (SFDR) compliant strategy to offer our investors greater transparency over the underlying environmental and social objectives we must measure the performance of our investments against.

In this strategy, we assess opportunities against the EU’s Taxonomy for Sustainable Activities, which sets out the criteria of what is considered a sustainable activity. This means investments need to both mitigate the effects of climate change while not causing significant environmental harm. They must also comply with minimum social safeguards.

Dillon Anderiesz: These factors are important as many of our investors are not just looking to invest responsibly, but also want to be able to measure and report on the impact of their investments to the diverse stakeholder groups they often represent.

We explored the possibility of launching a strategy in this space some time ago, but decided it was important to ensure our work was completely aligned with the SFDR. Understanding the regulations, adapting our processes, and building the necessary internal expertise took time. However, this thoughtful approach has been appreciated by our investors as they can  be confident that their money is being used for both environmental and social good.

What types of investors are green infrastructure debt strategies appealing to?

DA: Initially, we saw most interest from investors in Europe, and particularly in the Nordics. But that has now spread into the UK, parts of Asia, Australia and now, increasingly, North America.

We have seen interest from both pension funds and insurance companies, which includes growing interest from investors looking for alternatives that have a premium to green bonds, with attractive risk-adjusted returns and strong green credentials.

In what section of the market do you see the most opportunity?

DA: We have targeted a combination of investment grade and some sub-investment grade green infrastructure debt, to provide a balance and attractive risk-return profile for investors. That is an underserved space, because many strategies focus purely on either the investment grade or high yield sections of the market.

We are pursuing an average credit quality of BBB-/BB+, with individual investments having a credit quality at origination of B+ or above.

There can be attractive opportunities for investors in that crossover credit segment of the market, where the risk-return profile meets their targets.

Do investors need to sacrifice returns to pursue green investments?

TH: There have been several studies which have suggested a potential “greenium” (premium for green) that is paid in more liquid green bond markets. However, the converse is true for our green infrastructure debt strategy, which has historically outperformed other infrastructure subsectors.

This is due to a focus on private market opportunities with transactions typically negotiated bilaterally or with a small club of investors. Barriers to entry are high for these transactions due to the need for specialist expertise and also the large sums of money needed from individual investors wishing to participate directly in primary market transactions.

Which technologies and markets are you focused on?

DA: We are investing in sectors defined in the EU Taxonomy. This includes wind and solar, of course, but also hydroelectricity, energy efficiency, battery storage and bioenergy. The Taxonomy also allows for investment in other emerging sectors, such as the storage of hydrogen.

We like both brownfield and greenfield assets. We do not currently take development risk, but we do look at construction projects if the risk is appropriately mitigated, or the asset appropriately priced, to represent good value. Given the amount of capital that needs to be invested in renewable energy, the ability to finance greenfield investments is important.

In terms of geography, we are very much focused on OECD jurisdictions, particularly Europe and the US, where there is a strong pipeline of opportunities. However, we are seeing interest in opportunistic investments in less traditional markets. The Taiwanese offshore wind market is one example where we have seen attractive opportunities. There will be lots of green investment flowing into non-OECD markets over the next two to three decades and it is important to be able to access those geographies on a selective basis.

How much have you invested in green infrastructure debt?

TH: Our private credit platform has invested more than €2.7 billion across 39 green energy debt investments globally since 2014, achieving an average private credit premium of over 135 bps when compared with a liquid corporate bond benchmark. This also represents an attractive premium to the returns available in green bonds.

The portfolio represents green energy generation capacity of more than 15GW and delivers an annual CO2 emissions reduction in excess of 14 Mt CO2e. This is equivalent to powering around seven million homes and removing around five million cars a year from the roads.

How are you working with the institutional investor community?

DA: A number of our large clients have been at the forefront of driving thought leadership and best practice for responsible investment strategies. We have worked closely with these investors over a number of years in building private credit portfolios, which has supported us in designing the green infrastructure debt strategy.

A well-publicised recent example is the partnership we formed with KLP, Norway’s largest pension manager. KLP is the cornerstone investor and a key partner for our green energy debt strategy, and we have greatly enjoyed working closely with them to ensure the strategy is accessible for other like-minded investors in the pension and insurance sectors.

How has covid-19 impacted green infrastructure debt?

TH: Renewable energy continues to be one of the largest and more resilient infrastructure sectors following the pandemic. The sun kept shining and the wind kept blowing, and many assets could be operated remotely despite the disruption. Of course, many greenfield projects initially faced construction delays or briefly postponed financing, but borrowers quickly returned to the market. It was a good story from the perspective of credit performance, with the pandemic proving that these assets can withstand macro shocks.

By the end of 2020, the value of renewable energy dealflow had returned to pre-pandemic levels. Meanwhile, the decarbonisation agenda, which had already been gaining momentum, was accelerated further still. Building back greener to stimulate economic growth and achieve net zero should continue to be a tailwind for the sector in the years ahead.

Tim Humphrey is co-head of private credit, Macquarie Asset Management
Dillon Anderiesz is private credit product specialist, Macquarie Asset Management