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Edition 1 - Article 2

Why infrastructure debt is flying high

After years in the background, infrastructure debt has found itself in the spotlight thanks to a solid track record and evolving opportunities.

In Australia, the official cash rate is at historic lows, and further falls are likely. The Bank of England has set rates not much above 300-year lows. The Federal Reserve has cut rates twice in the second half of 2019. The Bank of Japan’s 10-year government bond yield has been negative most of the year.

In 2019, it’s tough for investors to find both yield and security.

Enter higher yielding infrastructure debt, an asset class that while not quite embryonic, is just an adolescent among investments, thus less understood.

Mezzanine or subordinated infrastructure debt sits between senior debt and equity in the capital structure. As a result, it tends to command a higher yield than senior debt and the stable nature of infrastructure assets means default rates are generally low1.

It has been around for more than 20 years, albeit less understood than most other assets. It now has a track record – something that hindered it previously – and that record demonstrates good, stable returns. It is also not cyclical, which is crucial for any portfolio.

This year, Infrastructure Investor magazine began publishing a list of the top 10 infrastructure debt managers, reflecting the growth of the asset class. The rankings were based on the amount of direct infrastructure debt investments between January 2013 and August 2018. Of the top five, two were from the United States, two from Europe, and the fifth was AMP Capital from Australia.

While infrastructure debt comes in many forms, finding the perfect combination of secure returns, a visible investment pipeline and a sustainable investment strategy remains at the heart of the market’s challenge” 

- Infrastructure Investor

Infrastructure assets provide essential services that support economic growth and generate productivity. In contrast to most assets, investors often look for regulated and contractual environments.

The best deals usually come in one of two places. The first is in existing regulated environments. AMP Capital has some excellent examples of investing in water utility companies and gas distribution pipelines. When there is only one such asset in a region and the infrastructure is regulated, we can be confident of the returns that business will generate.

The second is in deals where long-term contracts are in place. For example, a gas-fired power station might have a contract to sell power to a third party and know the price the power will be sold at and the volume that will be sold. The deal provides stable cash flow with low volatility.

Existing players in the infrastructure debt market have a comparative advantage, simply because of the high barriers to entry for other players. The asset class performs across market cycles and works best when there is political stability and mature legal, tax and accounting frameworks.

The investment team must negotiate strong covenants with high protection for investors and implement a rigorous credit process and due diligence on the borrower.

A secured infrastructure debt opportunity will typically have very detailed financial covenants, negative and positive undertakings by the borrower and a comprehensive security structure which includes fixed and floating charges over all the assets of the company we are lending to.

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The characteristics of infrastructure debt, including long-term contracted cash flows, regulated environments and a low correlation with traditional asset classes, are very attractive to some investors.

We’ve had a belief for some time that there are attractive returns in the subordinated space and at various points in the economic cycle, infrastructure debt can also look attractive relative to core infrastructure equity.

We are at one of those points now because the amount of capital available for equity infrastructure has pushed prices up and there are very few managers out there such as AMP Capital that are willing (or able) to provide more than US$200 million in subordinated infrastructure debt to a single asset2.

For institutional investors looking for long-dated products with quality cashflows and genuine defensive characteristics, infrastructure debt often fits the bill.

 AMP Capital view

 AMP Capital targets a gross internal rate of return for its infrastructure debt assets of 10 per cent3 with an emphasis on stable long-term yields with low volatility. AMP Capital prefers to be a lead arranger and is focused on high-yielding subordinated debt of defensive companies.

Each of AMP Capital’s investment strategies tend to have around 15 investments in the US$75-500 million range and debt maturities are typically of seven or eight years. It targets OECD and developed countries across transport, energy, utilities and telecommunications.

Energy assets across Europe and the United States are currently attracting much investor interest while utilities are stable. The renewables sector has provided increasing opportunities also across Europe and the United States.

Telecommunication is an attractive sector, spurred on by the roll out of mobile phone towers for 5G networks across the United States. Investing in digital infrastructure, such as fibre networks and data centres, is also an emerging theme within infrastructure.

AMP Capital provides capital for acquisitions, refinancing and serves as an alternative to owners exiting a business. According to Willis Towers Watson, AMP Capital sits in the top 15 infrastructure managers globally with US$16 billion in infrastructure equity and debt.

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1 Moody’s investors services Infrastructure and Project Finance Default Research 2018
2 Infrastructure Investor, 2019
3 Target returns are merely estimates and there are no guarantees that the returns will be achieved. Past performance is not a reliable indicator of future performance

Important Notes


Edition 4 - Article 3

The accidental economist
