Infrastructure debt has become relatively more attractive, though, with a substantial revitalisation of its risk-adjusted return.
The sharp rise in interest rates in 2023 altered the landscape somewhat for private infrastructure debt. Institutional investors have allocated less capital to this asset class over the last few months in terms of both absolute value and the denominator effect, preferring liquid assets instead. Infrastructure debt has become relatively more attractive, though, with a substantial revitalisation of its risk-adjusted return.
It bears repeating that the basis of this asset class is the interest rate, plus a lending margin. Amid interest rates that have now plateaued at a high level, private infrastructure debt offers a return similar to the yield available on ‘core’ infra equity assets about 18 months ago: levels are currently nudging 5 to 6% per year on senior debt and range from 8 to 10% for junior debt, a strong outlook for an asset class traditionally seen as ‘defensive’1. The expectation is that this potential for relative value will gradually increase the debt instrument’s weighting alongside infra equity and other real assets in the unlisted components of investment portfolios.
Premiums, sourcing and non-financial specifications
For all that, there are specific demands from institutional investors for private infrastructure debt that asset managers must to be able to meet, by delivering on the promise of complexity and illiquidity premiums as the basic value proposition of the asset class. The backdrop to this has been dominated over the last few months by a slowdown in refinancing operations and in mergers and acquisitions, along with longer transaction timeframes, as the parties involved adapt to new macroeconomic conditions.
One of the remaining challenges for specialists in the asset class is therefore to develop sourcing, to maintain a well-supplied pipeline of diversified transactions. From this point of view, the new ‘industrial revolution’ of the energy transition offers unprecedented opportunities for financing infrastructure, be it for decarbonisation, electrification or energy efficacy. Last November, the European Commission announced a plan to modernise power networks in the European Union in readiness for the rollout of renewable energy, which will call for investment of around €600 billion by 2030.
One of the remaining challenges for specialists in the asset class is therefore to develop sourcing, to maintain a well-supplied pipeline of diversified transactions.
The final set of demands concerns the fact that in nearly all cases, investment decisions in the asset class must adhere to detailed non-financial specifications with regulatory objectives. As a minimum, investment solutions must comply with Article 8 of GDPR, produce an impact and deliver robust non-financial reporting, all based on ESG analysis that can integrate negative external factors.
This set of criteria is now a decisive factor when choosing a real asset manager. Operators need to demonstrate not only that they are credible, but also capable of innovation in terms of both financial and non-financial performance.
[warning: The opinions expressed (i) are considered reliable by LBP AM and are based on or supported by the economic, financial, stock market and regulatory context and (ii) are given for information only.]
1Source: LBP AM, data as at 31/12/2023