The venerable European wealth management and investment house has around 150 years of experience in infrastructure. The manager of its team overseeing this asset class talks about the yield attractions of the area at a time when returns on conventional debt are often so meagre.
Private equity and venture capital receives a lot of attention in the wealth management industry these days. The infrastructure area is also proving to be a lucrative hunting ground for some players in the quest for yield in a world of ultra-thin or negative bond yields.
A recent report by Preqin, the research firm tracking alternative assets, showed that infrastructure chalked up a one-year return of 4.6 per cent in 2020, with only private equity and venture capital investments delivering stronger returns. More than half of the investors that Preqin tracked plan to increase commitments to the asset class in the next 12 months.
And the attractions become plain once enumerated: stable cash-flows, a degree of government protection (against competitors), and backing from real assets like a toll road or a power station. The term “infrastructure” can be elastic but broadly speaking it applies to entities such as ports, toll roads, logistics warehouses, utilities (gas, electricity, water, telecoms) and forms of transport. Investors often tap into it via debt and loans issued by arrangers of these entities. Some sectors – logistics – have waxed during the COVID-19 crisis; others such as airports have been hit by the collapse in air traffic. Overall, however, the sector is still gaining ground.
A firm with decades of experience in the field is Edmond de Rothschild, the European family office and wealth manager. The firm can trace its infrastructure resumé to when it funded railways in the mid-19th century. That accumulated expertise is worth exploiting, Jean-Francis Dusch, CEO, global head of Infrastructure and Structured Finance, CIO Infrastructure Debt at Edmond de Rothschild Asset Management, told this publication.
“We are a medium-sized, family-owned company and we choose where we can be relevant and strong,” he said.
The sector is attractive in an environment of very low interest rates, he said. To illustrate, French government 10-year bonds are just under zero; for the equivalent benchmark a German government 10-year bond is -0.25 per cent. In such an environment, obtaining government-like security but with a higher yield is a very potent proposition. Infrastructure can deliver that, Dusch said.
“We are true alternative arrangers of debt and provide a strong spread for secured debt instruments supported by a strong set of covenants,” he said.
Infrastructure-backed bonds, which are more junior in the debt repayment hierarchy, such as those that carry a BB rating creditworthiness from a rating agency, and have five, six or so years of duration, can attract spreads [above equivalent government debt] have been closer to 550-600 basis points out, he said.
“Remember, this is credit and not a disguised form of equity,” Dusch said.
There are no free lunches in economics but it is easy to see why infrastructure debt attracts investors left jaded by negative government bond yields. Paying for the privilege of lending money to the State is unappealing.
There is less risk of default than comparable forms of corporate debt, Dusch said. “That’s what institutions like.”
Data from the unlisted infrastructure funds sector illustrates what investors think of the sector. They raised $100 billion in 2020 across 101 funds, Preqin has reported, and assets under management rose by 3.5 per cent on 2019 to reach $655 billion as of June 2020. “Dry powder” – unspent capital – in value-added and infrastructure debt strategies rose by 30 per cent and 14 per cent, respectively. Most investors (89 per cent) said performance met or exceeded expectations over the past year, more than any other asset class. Some 54 per cent of investors plan to commit more to infrastructure in the next 12 months than they did last year, Preqin said.
Supply of infrastructure debt has been hit by the pandemic in some quarters, and the past year has been tough because of the pandemic in specific areas. The total volume issued in Europe (source: www.actuaries.org) was €10 billion ($11.8 billion) in the second quarter of last year (a fall of 9 per cent vs Q2 2019) and €12 billion (a fall of more than 50 per cent compared with Q3 2020). Most new issuance came from the renewables and telecoms sectors, suggesting that investors think that those sectors are more resilient to the pandemic.
Edmond de Rothschild formed its existing infrastructure business almost 20 years ago and started lending for infrastructure projects around seven years ago. It has raised €3.2 billion of money on its platform in connection with infrastructure. Edmond de Rothschild has an umbrella fund and can create sub-funds, attracting inflows mainly from institutions such as pension funds and insurance firms, and some private client money as well.
Edmond de Rothschild will work where there is a debt component, mitigating the specific risks of each asset they invest in, Dusch said.
Following infrastructure requires the debt team to understand the sector, including having an engineering background and relationships with the public sector where necessary. “We also advise governments as we are, after all, talking about a regulated industry,” Dusch continued. “It’s good to understand how the public bodies see these issues and the constraints.”
ESG considerations are now key and that has been noticeable over the past year, he said. Edmond de Rothschild uses independent auditors to verify if business areas in which it invests genuinely reduce C02 emissions, and by how much, he said. “We make sure we are close to the ground.”
There is some measure of exposure of regulatory risk. A lot of work has to be done in talking to different entities which are part of the whole infrastructure play, such as industrial sponsors, equipment suppliers, operators; it requires investors to understand the whole value chain underpinning an infrastructure asset.