On the back of falling interest rates and volatile equity markets, investors are looking for assets that can provide long-term, consistent returns. Astute investors have recognised that infrastructure debt enables them to retain credit allocations, but receive potentially greater returns than fixed income and cash investments. Compared to the infrastructure equity market, infrastructure debt is still a relatively small part of global investment markets. However, this is fast changing due to its favourable characteristics.

What is infrastructure debt

Infrastructure offers investors the opportunity to own the utilities and facilities that provide essential services such as road networks, airports and utilities, and which help drive economic growth. As well as investing in infrastructure equity, investors can invest in the debt side of high quality infrastructure assets. Infrastructure debt can be classified as senior or subordinated. Subordinated debt ranks behind senior debt and ahead of equity in a company’s capital structure, and offers investors the opportunity for attractive risk-adjusted returns. Outlined below are some of the reasons why an investor might wish to invest in subordinated infrastructure debt.

  • Potential for attractive risk-adjusted returns
  • Potential for strong cash yield
  • Inflation hedging
  • Low correlation with traditional asset classes

Potential for attractive risk-adjusted returns

Infrastructure assets are the foundation for basic, irreplaceable public services such as road networks, airports and water, gas and electricity utilities. These assets are necessary to support economic and social activity, and therefore benefit from relatively inelastic demand. Due to significant economies of scale, infrastructure assets cannot easily be replicated and are often regulated by frameworks in which they face little or no competition. Such natural and regulated monopolies reduce the impact of competition on returns. These factors are among the characteristics which give the infrastructure asset class its defensive nature.

Subordinated infrastructure debt can offer significantly higher margins than other credit-based strategies with only a moderate increase in the level of risk, providing investors with the opportunity to achieve attractive risk-adjusted returns.

Potential for strong cash yield

The return delivered by subordinated infrastructure debt is largely made up of yield, and is generally higher than the yields available from traditional fixed income securities and term deposits. The level of yield offered by subordinated infrastructure debt comes with a moderate increase in level of risk.

Inflation hedging provides a good match for inflation-linked liabilities

The yield from infrastructure debt securities generally consists of a fixed margin over a floating base rate. The floating base rate generally moves in line with movements in inflation, effectively providing an inflation hedge. This can make it an attractive option for many institutional investors such as pension funds as it provides a good match for their inflation-linked liabilities.

Low correlation with equity and fixed income asset classes

Infrastructure investments have a low correlation to traditional asset classes, and can provide valuable diversification in an investment portfolio.

 

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