Whither the debt funds?

Almost two years ago, all the talk in Europe was around the new phenomenon of infrastructure debt funds. Andy Thomson wonders why things have gone quiet.

IN MARCH THIS year, Hadrian’s Wall, the London-based start-up debt advisory firm, had cause for celebration. The European Investment Bank had just approved a £50 million (€57 million; $81 million) investment in the firm’s debut subordinated debt fund.

The dual-currency fund, being raised in partnership with insurance firm Aviva, was apparently on its way to a scheduled first close in the first half of the year as it sought to raise a total of £500 million plus €500 million.

Since then, however, no close has been announced. This is not to say that such an announcement is not forthcoming and that Hadrian’s Wall will not eventually silence any doubters regarding the momentum of its fundraising. Equally, nor is it the only European debt fund that has market observers wondering whether such vehicles will gain the traction within the region that was initially predicted. In February 2010, an Infrastructure Investor article boldly proclaimed: “Here come the debt funds”.

Twenty months later, and with debt fund closings notably thin on the ground, sceptics are entitled to ask: “Where are they, then?” Perhaps tellingly, the article in question identified a gap in the market as the reason why debt funds might flourish. It said:

“Although debt financing is beginning to pick up, debt availability is still well beneath pre-crisis levels, creating a clear opportunity for debt fund managers to fill the void”. What this may have overlooked is that market demand does not necessarily translate into investor demand.

TINY FRACTION

Almost two years on from their emergence, San Francisco-based placement agent Probitas Partners – which compiles global infrastructure fundraising data – is just beginning to see debt funds make an impact on its statistics. But this represents only a tiny fraction of a fundraising market that has in any case remained subdued ever since the global financial and economic crisis first broke three years ago.

One anonymous source told Infrastructure Investor: “You’re seeing a lot more [debt] funds launched than closed.

The thing is, if you’re investing in core, brownfield equity funds, you can expect a net return of 10 percent plus current income. They will provide you with more or less what you would expect to get from a debt fund. Debt funds have come about because of an underlying need for debt.

But are investors convinced that debt funds are the best way to get into infrastructure?” One answer to that, according to AMP Capital’s Andrew Jones, is that in one part of the world – Australia – investors
have long understood the benefits of infrastructure debt funds, and been prepared to back this up by committing capital. Jones is an Australian national based in the London office of AMP Capital, where he is a managing director of infrastructure debt. He says that the firm raised its first infrastructure debt fund in its home market in 1995. “We’ve had good penetration in Australia for so long,” he reflects. “We educated that market 12 years ago and people agree that it’s an attractive opportunity.”

This long track record – and accompanying proof of concept – may be a key aspect in the success or otherwise of infrastructure debt fundraisings. AMP Capital has sought to broaden out beyond its domestic Australian investor base with the OECD-focused debt fund it is currently raising. The fund posted a first close on €241 million in March this year, with Jones saying at the time that “demand has been strong from institutional investors in Asia, Europe, North America and Australia”. The fund is aiming to raise €500 million by the end of the year. 

Established track record was also cited by Westbourne Capital, the Australian fund manager which announced it had collected over A$1 billion (€738 million; $1.04 billion) for its debt fund in September this year. 

Westbourne’s David Ridley, in an interview with this magazine, cited “a long-term investment track record in infrastructure debt funds management; our core investment team has worked together since 2004”. 

SIMPLICITY THE KEY

But track record is unlikely to be the only factor. Some observers say that, in a time of such volatility in the global economy, investors are much more likely to back fund offerings that they don’t have to struggle too hard to understand. “Limited partners (LPs) have not frozen up like in 2009, but they are unsure where markets are going, so we will see conservatism,” says Jones. “Boring propositions that focus on safe companies and geographies are easily understood. Other managers have undertaken very smart strategies in terms of the way they have structured them, but simplicity is the key these days.” 

He says another factor is that infrastructure debt funds suffer at the hands of LPs who invest in infrastructure out of privateequity allocations. “We’ve done a lot of work with investors in the US, but the typical view is that you bundle infrastructure debt with private equity, where our target returns of 10
to 12.5 percent look a bit boring. With us, you get current cash yield of 9 to 11 percent in quarterly coupons, so you get consistency and predictability of yield. It’s a leap to get to the 15 percent you can get from your alternatives bucket, but then many LPs have had years of taking knocks in the private equity market.”

There’s another, more basic explanation for debt funds’ travails, however: the fundraising market as a whole is pretty dire. “I think some of the answer is the environment,” acknowledges Jones. “If debt
funds were springing up in the mid-2000s, they would have grown quickly.” Sadly, quick growth is not likely to return to developed economies any time soon.

SLOW RAMP-UP? THAT’S SUCH A DRAG

London-based Sequoia’s new €1bn debt fund has established a partnership with three banks, allowing it to readily invest funds raised

Sequoia Investment Management Company – an independently owned, London-based asset manager – is raising a debt fund which will not be focusing on originating loans directly, but has instead entered into an agreement with three banks to seed assets from their project finance portfolios.

The Seqimco Infrastructure Debt Fund, as the vehicle is known, is targeting a first close this quarter of between €100 million and €200 million and is aiming to raise a total of €1 billion, Dolf Kohnhorst, a director and head of sales and distribution at Sequoia, explained. The European Investment Bank has preliminarily approved a €25 million investment into the fund.

“We have entered into a partnership with three banks – one of them being [Portugal’s] Banco Espirito Santo – which are our preferred originators [of assets]. Our objective is to work with these banks (although we can also work with other banks) rather than originating our own loans. The fund aims to invest in a diversified loan portfolio financing essential infrastructure assets in core European countries – excluding Portugal, Greece and Ireland,” Kohnhorst explained.

The fund’s partnership with the three banks will allow it to readily invest funds raised, which Kohnhorst highlighted as a “big plus” when compared with other debt vehicles that have to originate their loans.

On its website, Sequoia says it will reduce “any drag on investor returns because of a slow ramp-up that is often a characteristic of infrastructure sector investment”.

The Seqimco Infrastructure Debt Fund will divide its portfolio into a Class A, composed of investment grade assets, and a Class B, which will mostly contain borderline investment grade loans.

Kohnhorst said that the potential EIB loan is set to help fund Class B acquisitions.

He also pointed out that Sequoia is looking to acquire loans “commensurate with where the market is now” in terms of price and structure. The fund is not planning to acquire the sort of low-margin loans that banks originated prior to the global financial crisis, he added.