The case for private debt

Opportunities in infrastructure debt

By Sundeep Vyas – Deputy Chief Investment Officer for Infrastructure Europe, Alternatives

Europe alone faces an infrastructure funding gap of around €3 Trillion1 over the next eight years. With governments constrained by budgetary pressures, the private sector is set to play an ever-larger role in financing the major initiatives that ultimately help to underpin every successful economy around the globe.

Historically low interest rates have compelled more and more investors to seek alternatives to traditional fixed income strategies in recent years. What they want are investments that can outperform the likes of investment-grade and sovereign bonds but which do not have markedly different risk profiles. Infrastructure debt fits this bill.

This space was once largely inaccessible to institutional investors. Banks dominated infrastructure funding. Today, though, unprecedented pressure to maintain balance-sheet strength has compelled banks to curtail their lending activities – creating potentially valuable opportunities for long-term investors such as pension funds and insurance companies.

By its very nature, infrastructure is geared towards providing essential services. It also involves “hard” assets. This tends to be reflected in stable valuations, higher ratings, predictable cash flows, “all-weather” performance and – in the event of default – stronger recovery rates for creditors.

Correlation levels and performance characteristics further underline how infrastructure debt can deliver diversification and risk-adjusted performance as part of a multi-asset-class portfolio. Over a nine-year period ending in June 2017, for instance, euro-denominated infrastructure debt demonstrated a correlation of only 66.5% with global bonds2. In addition, an active and growing secondary market is developing across the US and Europe, which should support liquidity.

European regulators have recently recognised the many potential benefits under the new Solvency II framework, with a reduction in capital charges for insurance companies investing in qualifying infrastructure debt. For example, the spread-risk capital charge for a BBB-rated corporate bond with a duration of 10 years is 20%, while the charge for a qualifying corporate infrastructure instrument with the same rating and duration is 15% – and the charge for a qualifying project finance infrastructure instrument is just 13.35%.

Infrastructure debt strategies can be complex. They may concentrate on senior investment-grade debt or move higher up the risk/return spectrum to encompass projects involving construction risk. Whatever the focus, success is likely to depend on an asset manager’s ability to originate opportunities, to negotiate transaction structures, durations and covenants and to diversify portfolios with a view to benefiting from every stage of the credit cycle3. At Deutsche Asset Management we believe experience and expertise are vital to generating alpha and capturing any additional illiquidity premium.

1Deutsche Asset Management estimate based on PWC and Oxford Economics forecast of investment needs, June 2017.

2IHS Markit, Bloomberg, Deutsche AM, January 2017. Infrastructure Bonds: iBoxx Infrastructure Debt; Corporate Bonds: iBoxx Corporate Debt. Analysis based on quarterly data. Past performance is not an indicator of future results.

3Driven by growing interest in this asset class, Deutsche Asset Management contributed to the development of the iBoxx Infrastructure listed corporate debt index family, filling the gap for a transparent benchmark. For additional details please refer to “Deutsche Asset Management, Understanding Infrastructure Debt”, July 2017.

More information?

Download here our Research Report 'Understanding infrastructure Debt'