What macroeconomic drivers do you see influencing the infrastructure debt market share?
The COVID-19 pandemic and energy crisis both brought a lot of attention to the infrastructure industry, pushing the ESG agenda and increased investments into renewables. Currently, investors seem to be rebalancing their portfolios away from core strategies to avoid the adverse impact of higher interest rates, and toward higher-yield core-plus strategies. In this context, infrastructure debt is gaining popularity, notably because of its highly attractive risk-adjusted returns.
What opportunities and challenges does infrastructure debt bring LPs in more stringent markets?
Competition is certainly increasing, with both traditional equity and established debt investors coming into the space. There have been a lot of new players drawn in by the opportunities that infrastructure debt offers. This increasing competition also extends to competition for the right assets.
It is likely the space will see more capital concentration in the market as larger firms pick up the bigger projects. On the other end, many new players are coming to market with smaller funds and pushing for projects in emerging sectors, particularly renewables. In the next five years, we will likely see even more smaller participants entering the industry with stronger specialization in these verticals, which can be good news for investors. Diversification is always attractive – not everyone necessarily wants to put all their eggs in the “larger firms” basket.
What should LPs new to infrastructure debt know about entering a niche market?
One needs to keep in mind that niche markets like infrastructure debt often have specific needs and characteristics. Infrastructure and debt managers will certainly be knowledgeable, but combining the two components may present a learning curve for some. Infrastructure debt funds can prompt more involvement from the administrative side, in particular around loan servicing or portfolio monitoring.
Efficiently managing a loan portfolio and its revenue base requires a solid understanding of debt, but equally as important is the ability to gather, aggregate and analyze data related to the loan portfolio, the borrowers and agreed covenants. This is what allows managers to gain insights into the portfolio’s performance, flag any credit risks as early on as possible, and simply take timely and informed portfolio management decisions.
Both managers and LPs need to ensure their back and middle offices adapt to fit the needs of a multilateral strategy, and ensure that their tools, systems, processes, and their team’s skill sets are in place, either in-house or through the use of external resources.
How can infrastructure debt evolve as the US puts more energy into national infrastructure projects?
Infrastructure has always been a way for governments to spend themselves out of a crisis, create jobs and get the economy back on track. Over the past two years, the US legislator voted on two major Bills which have contributed to raising the US market’s appeal among global infrastructure investors, specifically to accelerate the energy transition. Governments will partner with the private sector to execute on these projects, including with private equity types of investors.
Of concern, however, are both the availability and cost of debt, and the fact that many banks seem reluctant to finance anything riskier than core strategies. Consequently, many managers are looking at non-bank lenders and debt funds to finance new projects or to refinance existing ones. This opens up a lot of opportunities in this niche asset class.
This article was originally published in Preqin’s Infrastructure Quarterly Update.
