A rising star in institutional investment is infrastructure. It is particularly popular for those looking for diversification in their fixed income portfolios as a means of access to long-term credit opportunities. In lieu of this, infrastructure debt has also emerged as an issue for such investors. Investment managers persist to look for means to create new debt vehicles for several purposes. These include direct lending to infrastructure operators, structuring of private lending programs, and access to reputable municipal bond markets.
With the intention of assisting institutional investors in penetrating the asset class, Schroders founded a new infrastructure finance capability last September. Co-Head of Fixed Income at the said institution, Philippe Espinard expressed his opinions on infrastructure finance as an asset class. His statement went as such:
“We believe it is currently benefitting from increasing demand from long-term institutional investors due to the increasing supply of projects, partly attributable to macro-economic factors and changing regulations.”
Is It Listed or Unlisted?
An infrastructure fund generally exists to enter into a form of loan arrangement, instead of making a direct equity investment. This is viewed form a structuring perspective.
In the case of a listed fund, a re-characterization emerges from the option of the purchased debt. The process here is that the aforementioned debt is sold and converted into an equity instrument – these instruments can then be in turn bought and sold as shares. This process is what tends to confuse a lot of investors.
Another popular matter is the private, unlisted fund. Craig Cordle, an investment funds Group Partner at Ogier in Guernsey, defines the private infrastructure fund as something structured as a limited partnership. He also comments that there are many possibilities for bespoke structures, depending on needs by investors. Some illustrations are using a limited company instead of a partnership, or putting a limited company on top of a limited partnership. These options allow investors to hold equity, as well as a partnership interest in the case of the latter option.
Important considerations for structuring infrastructure funds are the location of the assets as well as the target investors. These precede the decision on determining the domicile of the investment vehicle. Another relevant variable would be the location of the investment manager.
Cordle adds that the manager will also have to consider the marketing strategy of the fund and its position under the AIFMD. Additional questions are regarding the possibility of targeting EU investors, taking advantage of National Private Placement Regimes, as well as the underlying factors for such. (e.g. the need for the manager to require full passporting rights)
“Also, think about what advisers will need to be appointed and how exactly investments will be made. Will this require other entities as part of the overall structure? If seed investments have been identified, this will impact the disclosures which will need to be made to investors and the level of verification of that information required,” Cordle further explains.
The Need for 4.6 Trillion US Dollars
While Europe is starting to see more infrastructure opportunities, the US infrastructure market is still the one enjoying most of the investment possibilities. US President Trump is currently waiting approval for a 1 trillion US Dollar Plan, and infrastructure projects will increase significantly if it pushes through. At present, 80% of the capital for such projects are supported by the municipal market.
Sales Director of MUFG Investor Sevices Michael McCabe cites several of Trumps investment interests, including the Alaska Pipeline and LNG Project. He explains that Trump’s influence in preference to US- built and supplies pipelines has resulted to a more open environment for related investments. He adds that the energy infrastructure sector is also a profitable prospect, saying that “…clients are buying into existing pipelines, they are building wind farms. We see interest both in brownfield sites and greenfield investments, depending on the risk appetite of the end investor.”
A significant amount was also made ready for the purpose of investing in dry powder (amounting to approximately 150 billion US dollars) at the end of the previous year. Additionally, another 50 million had been raised for the first quarter of 2017. In terms of supply and demand economics, infrastructure managers are working to respond to the growing need of investors, which is a positive effect.
McCabe believes that there will be continuity in demand for assets including but not limited to renewable energy and core infrastructure assets. He states that the only thing that could put a material constraint on the prospect is a global economic collapse.
The Grand Prairie Wind Project
One way to get clients is to convince them to engage in quasi-PE fund structures. But the growing presence of global infrastructures have also led asset managers to represent their clients by investing in this option. A notable example is Allianz Global Investors, who invested 400 million US Dollars on the Grand Prairie Wind Project. This project results in a 400-megawatt wind farm in Nebraska – the largest wind energy project in state history.
Allianz Global Investors privately placed 20-year unlisted bonds with US and European investors using their infrastructure debt platform. Berkshire Hathaway Energy created its subsidiary BHE Renewables to specifically serve as the investment’s operator. This is in lieu of the company’s plans to expand into unregulated renewables like wind, solar, hydro and geothermal energy.
“Our first US transaction was the Indiana Toll Road. We made a USD700 million long-term investment and that quickly put us on the map in the US. Since then, we have a had a good run in transportation and have made three transactions in total: the Indiana Toll Road, Chicago Skyway, and most recently (Q4 2016) the Pocahontas Parkway in Virginia.”
This was the statement made by Jorge Camiña, Director of Infrastructure Debt in Allianz Global Investors. He was referring to the company’s focus on P3 and transportation assets, just when they had only created an infrastructure debt team in 2012. Since then, AllinZ GI has been looking to penetrate more expansion opportunities.
Camiña relates that they had observed that tax-exempt financing covered many P3 and transportation assets, resulting in a limited number of deals in the sector. Thus, they moved their focus on the power and energy industries, where they have been putting their work and attention for the last 12 to 18 months. The Grand Prairie Wind Project was one of the results of this refocus.
Power assets, particularly those dealing in renewable energy, enjoy tax incentives that are difficult to monetize due to the complicated structuring involved. Thus, there are only a few prospects that suit an institutional investment grade profile.
In the case of the Grand Priarie Wind Project, the sponsor has its own tax capacity, which makes access between institutional investors easier. Their process involves monetizing the tax incentives in a straightforward approach, getting rid of the complexities characteristic to power assets.
Camiña also says, “The second transaction we recently closed in February was also in the wind space: the Balko Wind Project based in Beaver County, Oklahoma. We are confident we’ll be able to close a few more deals in our pipeline by the end of the year. That said, tax reforms could possibly push back on the timing of some of these transactions, when there is more clarity on what those tax reforms look like.”
In Balko Wind’s case, its owner DE Shaw Renewable Investments LLC was assisted through funding for refinancing purposes. It was done as a “back-leverage” loan, tailoring to the structure of the company conveniently.
It can be noted that both investments have slight differences – the Grand Prairie deal was executed while the project was already in operation and was financed by its own operator, while Balko required the trade finance from different banks and needed the help of Allianz GI with its refinancing. Presently, Balko has been operational for a little over a year.
Both deals have credit profiles based on the operational assets – they tend to have a highly rated counterparty that is also credit worthy. This entity (generally a utility) purchases the relevant certificates under a long term-contract called a Power Purchase Agreement.
“Since the Borrower is a special purpose vehicle that actually owns the Project, the credit profile of these transactions is typically ring fenced from the Sponsor. We finance specific assets so it’s just project risk that we are taking. Our financing is specifically tailored to the capacity of the cash flows of a particular project,” adds Camiña.
The Archmore Infrastructure Debt Platform
This platform was founded in Europe as a response to institutional demand. It was established by UBS Asset Management and targets mid-market lending opportunities. The firm’s Global Head of Infrastructure in Real Estate & Private Markets Tommaso Albanese says that this particular part of the market was identified by the company as lacking in necessary capital. They then saw this as a chance to focus on the private side of the market instead of the public one. They aim to provide debt financing as well as create investments for clients using attractive risk profiles. He also states the following:
“Infrastructure represents the most conservative, but equally a very attractive area of private debt. Investors are looking for alternatives to fixed income investments and infra debt offers them a yield pick-up thanks to the illiquidity premium. These are assets with long-term, stable cash flows, typically secured with a pledge on the underlying physical assets. This is the `real asset’ aspect to the asset class and that gives institutions a lot of comfort.”
The company has invested in different ventures in Scandinavia, Spain, and France, focusing on ferry and port transportation as well as energy. The firm is preparing to launch its next fund and are hoping to fully deploy Archmore by the end of the year. Their venture has raised 630 million US Dollars from 17 institutional investors all across Europe and Japan. Albanese says that there is sufficient demand and expects it to stay that way. He also explains that infrastructure enjoys working with long-term investors for long-term prospects. This “alignment of interests” is an advantage of the venture.
He also discusses advantages in borrowing, reduction in related risks, and the growing activity in more areas in the energy industry.
The Third Way
Based on the previous discussions, it has been proven that investors are willing to participate in co-investment type ventures, as well as taking direct exposure in the assets through long-term private bonds. However, these solutions may not be desirable for all investors. There also several considerations. For example, investors may be willing but do not have the expertise. They may need advice due to the complex nature of the deal and its associated risks. Lastly, they would want to monitor their risks, and keeping in touch with an asset manager they are comfortable with in order to be updated and informed may be necessary. These considerations were enumerated by Charles Dupont, Head of Infrastructure Finance in Schroders.
He explains that Schroder was able to raise 1.1 Billion Euros by sourcing from 12 different investors, each involved in five different funds. For every instance they structure a dedicated investment mandate, the decisions are uniquely tailored to the investor’s specific demands, such as average maturities and diversification.
Every fund is made for an investor or a group, and once the fund ends, no one else can come into it. In short, they are exclusive to the original investors. Due to the majority of European insurance groups, most of the allocations are under the senior secured loan infrastructure fund.
Dupont expounds on discount rules based on criteria, offering a 30% discount in capital requirements. This deal has made the venture into an appealing relative value opportunity for investors.
The Pick-Up Premium
Allianz GI’s deals involve a single portion of bonds that are amortized over the contract’s life. Returns are generally deal-specific, but a commonality is that most organizations want to get a pick-up premium on the price of the equivalent bond of the PPS off-taker. Camiña explains the process involved with this interest:
“Let’s say that the bond of the utility off-taker for a similar average life as the project is trading at 4% yield. If one then prices in wind risk, operational risk, liquidity premium and so on, this will lead to adding a pick-up premium to that coupon. This pick-up varies a lot depending on the deal and the sponsor.
“Ultimately, there are three ways for institutions to invest in long-term resilient credit: sovereign debt, utility bonds, and infra debt. If you want a pick-up over sovereigns you buy utilities, and if you want a pick-up over utilities you buy infra debt, which is where we come in.”
Dupont says that there are four different sub-segments involved in the senior secured debt arena. Long duration credit, short duration credit, brownfield sites, and greenfield sites are the different sub-segments, each offering different relative value opportunities. Brownfields are existing operational assets, while greenfields are new ones with construction risk and no proven history in performance.
“Let’s first consider lower RV opportunities in the market. For example, long duration greenfield projects have seen evident demand from investors looking for asset liability matching instruments. But with a lack of pipeline investments, and significant investor capital to deploy, this is supporting low rates relative to corporate credit.
“By contrast, in short duration brownfields, where companies are offering loans of five to seven years, they have consistently offered 200 basis points above Euribor over the last five years. The team at Schroders is very focused on brownfield projects rather than greenfields in the senior secured fund.”
Schroders has completed 19 transactions across five funds over the last 12 months overall.
Risks include regulatory, political, and economic ones, each having the possibility of affecting performance and future cash flows. The risk arises with the potential of additional infrastructure projects. Cordle states that changing regulations and economics are also factors that can contribute to risks. “No infrastructure asset is fully protected.”
As an illustration, the United Kingdom is known as Europe’s most important infrastructure due to its pioneering efforts in privatization in airports, water companies, and rail line operators. However, Brexit emerged and the market changed in adjustment to that. Dupont discusses that the Sterling-denominated projects make it more difficult for investors outside UK. Political uncertainty is also a contributing variable. Dupont advises that “At Schroders, our client base is Euro-denominated and we are recommending them to invest in Sterling-denominated infrastructure at a later stage when the impact of Brexit will become clearer.”
Strength of Partnership
Confidence is a necessity for investors and managers whether they come from the US or Europe. Fund administrators significantly validate assets and provide independence to ensure controls as to the fund’s operations. A form of support for managers is to provide finance for subscription lines, advises McCabe.
He further states that investors need assurance that qualified people other than the investment manager have looked at calculations, management fees, and have also confirmed and verified returns through a third party. He explains that MUFG Investor Services plans to do independent reconciliations and perform checks, both on a cash flow and investor perspective.
They have also included annual audits, look-through reporting, and working with large pension funds to increase the assurance of fraud risk mitigation to their investors. The company boasts leadership in the I industry as to accuracy, depth and breadth of reporting, as well.