Here, our Associate Director for Infrastructure Debt, Giles Gray, shares an overview of 2020 in the emerging field of private infrastructure debt.
What makes investments linked to certain kinds of infrastructure so attractive in times of crisis?
Infrastructure, in general terms, refers to the physical structures and networks that are used within society to provide services that are often essential to the users. The core group of assets can be categorised into transport, energy, utilities and communications, each of which is comprised to varying degrees of non-cyclical assets. And by non-cyclical we really mean an asset with cash flows which have a low correlation to GDP; whilst transport assets have been impacted by the pandemic, these effects are mainly due to government restrictions and citizens’ reticence around mobility.
Within these categories, sought-after attributes by investors looking for defensive positioning include high barriers to entry, a regulated environment, clear visibility into cashflows and strong positioning within the industry. Once one or a combination of these attributes are in place, investors can be reasonably confident that the business will be well-protected in returning those consistent cashflows during a market downturn. This low correlation with GDP, compared to more traditional listed equity or fixed income investments, provides diversification benefits to portfolios which include an allocation to infrastructure, and the asset class has been increasingly attractive to investors in recent years for this reason.
As you mention, transport assets have been hit hard by movement restrictions. Utilities tend to be more protected by contracts and regulation, whilst communication assets are in high demand thanks to the rise of e-commerce and work-from-home. How have energy assets performed through the pandemic?
The slowdown in transport, trade and economic activity across the globe has had a marked impact on global energy supply and demand patterns. We typically focus our investment activity around the power generation and midstream energy sub-sectors. These are essential infrastructure sectors, and we seek to invest in assets that are underpinned by revenue streams that are contracted over the long term through take or pay arrangements or fixed price power purchase agreements. We consider this strategy has provided significant protection to any wholesale price volatility and ensured that our assets have performed reasonably well through the pandemic.
We continue to see projects in the sector as attractive propositions, due in large part to the opportunity provided by the long-term structural shift towards renewable energy, and allocations to energy are likely to remain an important part of portfolios going forward.
Why would investors consider infrastructure debt as an alternative to other forms of exposure to infrastructure assets at a time like this?
Infrastructure debt and infrastructure equity strategies often target similar assets, which benefit from the same underlying business traits - including non-cyclical and stable cash flows. The differentiating factor is that investors in infrastructure debt typically seek a slightly lower target return in exchange for a more senior position in the capital structure and a more stable cash yield.
For this reason, returns on infrastructure debt tend to be less volatile than infrastructure equity investments, offering more defensive characteristics to the portfolio.We believe these defensive characteristics position it well to generate consistent returns, even during a potential downswing in the global economy and in an environment where corporate defaults are rising.
How is the low interest rate environment affecting the infrastructure debt market?
In recent years we’ve seen significant growth in the number of institutional investors looking to allocate funds towards the private debt market. Many of these investors view private debt as an attractive substitute for fixed-income, as it offers an illiquidity premium compared to fixed-income assets of otherwise comparable risk. Infrastructure debt offers a similar illiquidity premium and an enhanced risk-adjusted return, thanks to the stable characteristics of the underlying assets.
In a world where very low interest rates have become predominant and government bonds and corporate bonds continue to trade at low levels, the yield pick-up and enhanced risk-adjusted return of private infrastructure debt should continue to be attractive.
Infrastructure is likely to feature prominently in ongoing fiscal stimulus programs. What new dynamics do you see playing out in this new wave of investments?
As the global economies emerge from this pandemic, we expect that infrastructure projects emanating from fiscal stimulus programs will include a much sharper focus on environmental, sustainability and governance (ESG) considerations. There is a growing awareness of the benefits of investing sustainably, and it has been a significant component of our own investment process for many years. The assessment of ESG factors gives us greater insight into areas of risk and opportunity that could impact long-term performance and reputation of our investments.
We expect a number of governments will consider this an opportunity to pivot towards a new generation of green infrastructure – for example projects in the areas of renewable energy and sustainable transport, and more traditional projects that incorporate sustainable design and construction methods.
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