Public infrastructure spans roads, bridges, airports, utilities and other essential facilities. Based on current trends, global infrastructure investment is set to reach $2.9tn (£2.3tn) this year, falling short of an investment need of about $3.4tn, according to the G20’s global outlook. The total investment gap stands at a staggering $15tn. For Europe, the biggest need is in transport and energy.

   

   

It is therefore unsurprising that governments often look to institutional investors when it comes to filling this gap – while investors in turn might find infrastructure a useful asset class to help them achieve their investment objectives. 

 

 

Pension funds and insurers have typically approached infrastructure from the equity side to finance infrastructure projects and companies, but is this still the case? 

 

After the global financial crisis, banks retrenched somewhat from infrastructure debt. Insurers then started to explore the asset class, which drew in other institutional investors. This has led to the emergence of infrastructure debt as an institutional asset class, says Anish Butani, a director at consultancy Bfinance. 

 

“Initially that manifested itself as being an avenue for investors looking to match liabilities. Especially when interest rates were very low, there was still focus and emphasis on the illiquidity premium,” he notes, with infrastructure debt offering low defaults and high recovery rates. 

 

Despite the currently higher interest rates and attractive corporate bond returns, the illiquidity argument still holds, he believes, pointing to the spread between public corporate bonds and illiquid infrastructure loans. In the investment grade segment, returns on infrastructure debt range from around 150 to 275 basis points over the government bond yield, to about 275 to 375 basis points for crossover credit – which is slightly junior to investment grade – and to over 400 basis points for sub-investment grade, according to Butani. 

In addition, the market for infrastructure debt is now deeper and more established, with a well identified group of managers participating, he adds.  

 

In terms of the available products, the lion's share has been around investment grade, but “there's a growing realisation that there is a role for debt to play, especially sub-investment grade debt. If you look at where base rates are today, if you have a base rate of 3-4% and add a spread of 4-6%, you're looking at a yield of high single digits, which is very attractive and compelling,” Butani believes.  

 

Infrastructure equity normally has more upside than debt – returns tend to be around 600 to 700 basis points over government bond yields. However, debt comes at a more secure position in the capital structure and offers a contractual income, so it could help to diversify a matching portfolio. 

While this can be attractive, infrastructure debt needs to complement the other pieces in a portfolio. The role of infrastructure must be considered at scheme level, says David Fogarty, a professional trustee at Dalriada Trustees. Assessing liquidity and diversification, and considering other assets already in the portfolio, such as investment grade credit or multi-asset credit funds, is key.

 

“Fundamentally what we are trying to figure out with the advice that we take, is, would this asset fit with what we are trying to achieve with the scheme?” says Fogarty.  

 

Schemes that are relatively large, well funded and which have governance budgets that allow them to, for example, set up an investment committee to look after such investments would be more likely to consider infrastructure debt, he suggests. 

 

Even so, trustees need to have a reason to go looking for new opportunities – and those with a high funding level might not feel like they need to. The fact the UK’s pensions policy is in flux is not conducive to making new allocations either. 

 

“What you have at the moment is a strange sort of hiatus,” Fogarty believes – where schemes are either moving to buyout, therefore making a new illiquid investment not likely – or, if they are looking at runoff, they are “sitting on the fence” because they want to understand what comes out of the chancellor's Mansion House reforms. 

 

"Trustees and corporates are cautious and need to have clear reasons to make changes. It's not necessarily a good thing, but there is a certain degree of herd comfort,” he admits. “The worst with an illiquid asset class is you buy it and change your mind.” 

 

However, where the trustees are confident the scheme will run on for 10 years or more, “it starts to become an opportunity”, he says. 

 

Then, the case for investing becomes more about individual preferences. Fogarty’s would be for a meaningful investment to make the governance effort worthwhile: “If you have a £1bn fund, 5% is £50m. That's a meaningful allocation, 2% at £20m probably isn’t.” 

 

Many DB schemes are now aiming for buyout, but despite market capacity put at anywhere between £50bn and £80bn, this “doesn’t scratch the surface” of the existing liabilities, says Gregor Law, another professional trustee at Dalriada. This means trustees will need to consider alternative ways, whether it is run-on or a capital-backed journey plan. 

 

In addition, changes to surplus extraction – including a reduction of the tax charge and a statutory override to allow extraction before wind-up – will “inevitably lead to a modest rerisking” and allow schemes to take a longer term view on investments. 

 

“Why should trustees hand money to insurers when they just rerisk for profit?” he adds. 

 

 

An allocation might be easier to fill with infrastructure debt than equity, as Annette Bannister, head of infrastructure debt EMEA at MetLife Investments, says there is more opportunity on the debt than on the equity side. This is because the former makes up a larger piece of the capital stack, with potentially up to 90% of a relevant project or company financed by debt. 

 

Choosing infrastructure debt also allows investors to be more diversified in terms of cash flow, she argues. 

 

“On the debt side, you do have opportunities to be in different maturity buckets. So you might look at it and say, now I'd be comfortable doing seven years of risk here, or actually be comfortable doing 10 years,” she explains. 

 

Bannister also argues that private debt is more liquid than private equity as it changes hands in the secondary market and points out that typically only a management fee is paid, rather than a performance fee. 

 

She sees infrastructure debt as a complement to a public fixed income portfolio, rather than an alternative asset class, which allows investors to add diversification and yield to their fixed income portfolio.  

 

In addition, private markets offer access to management that public markets do not. “You can ask a lot more questions, information-wise you get a lot more than you would on the public side, and you also have the benefit of having financial covenants and security, which help to protect you," she explains. 

 

The risk and return trade-off, however, needs to be right. In competitive markets like renewables in Europe, for example, MetLife does not always think the risk-adjusted returns make sense. 

 

“There are lots of other things that you can invest in if you're looking for a sustainable investment strategy and infrastructure,” she believes, citing rail electrification and service operation vessels for offshore windfarms, as well as community-oriented assets. 

 

What is more, when it comes to UK offshore wind, there is currently a lack of new projects to finance, with the government’s latest auction having failed. 

 

For levelling up, “I think infrastructure is absolutely the key to getting that done, but from a debt perspective, anyway, it's about those deals coming to market for us to finance them”. 

 

 

Demand for infrastructure cooled last year, but Butani thinks this could change. 

 

“No one's expecting this year to be a record year, but I think there's an expectation that conditions should ease compared to how they were last year,” he says. 

 

Butani advises those that are considering the asset class or already choosing managers to "really look at the assets” and understand the kinds of risks that managers are taking because the assets contained within infrastructure debt can differ greatly. 

 

“In an infrastructure fund, you could be exposed to a waste plant and an airport. These are two different types of businesses with two completely different sets of risks. So really looking to understand the type of risks and how managers are underwriting those assets I think is very important,” he says. 

 

The type of underlying asset can change in infrastructure debt, but how deals are underwritten should be consistent, he adds. 

 

“Are managers sticking very close to their knitting in terms of not just the types of assets, but the types of risks that they're taking? That's very important as we're in this slightly different investment environment.”



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