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Pensions get access to long-term debt funds
By Steve Johnson
Every cloud has a silver lining, as the saying goes, and the ongoing retrenchment by the global banking sector, with its deleterious effect on economic growth, is creating opportunities for others, namely cash-rich institutional investors.
One such potential investment opportunity is rooted in the debt commonly used to fund infrastructure projects, anything from social infrastructure such as schools and hospitals to the energy, transport and water sectors.
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While institutions have long invested in infrastructure equity, exposure to the debt backing such projects has been patchy, despite a range of characteristics that should make it attractive to pension funds, insurance companies and sovereign wealth funds, such as its long-term tenor, inflation-linked returns and relatively low risk profile. Some in the industry are now looking to square this circle. “The age of austerity has inadvertently created countless win-win opportunities for UK pension schemes as managers of infrastructure seek to tap into sources of long-term funding,” says Robert Gardner, co-chief executive of Redington, a consultancy.
“With long-term liabilities, pension schemes have always been the ideal owners of infrastructure assets. This is the time for pension schemes to step out into the limelight and be the 21st century social capitalists.”
And the opportunity is certainly not limited to the UK. The European Commission and the European Investment Bank are currently working on the Europe 2020 Project BondInitiative, designed to drum up private sector financing for some of the “unprecedented” €1,500bn ($2,000bn) to €2,000bn the two bodies estimate needs to be spent on infrastructure in the European Union by 2020.
Australian asset managers such as Westbourne Capital and AMP Capital are also in the vanguard of the first wave of specialist infrastructure debt funds.
“The sheer quantum of debt that is needed to meet infrastructure needs globally is immense,” says David Cooper, head of infrastructure debt at Barclays, which is currently seeking investors for a planned £500m ($770m) infrastructure senior debt fund.
Mr Gardner has a simple explanation as to why the sector has not taken off before – investors simply could not get their hands on infrastructure debt. “[In the UK] almost 97 per cent ended up on bank balance sheets. It’s a deep market but one that wasn’t available as a separate product, because the banks wanted to keep it for themselves. It’s a new asset class in terms of its availability to pension funds.”
Pre-September 2008, banks such as Barclayswould typically act as a lead arranger on infrastructure debt deals, Mr Cooper says. Barclays might lend £100m, and then sell three quarters of this on to other banks to spread the risk. Now this model is in abeyance.
“Banks are facing regulatory and funding pressures which change on an almost monthly basis. It’s very difficult for a lead arranging bank to take a view on other partners coming through on a deal. Before we could be confident there were 20 banks willing to get involved,” says Mr Cooper.
Club deals, where several banks join forces to fund a project, have gained some traction, but can be a long, drawn-out process. Barclays’ proposed solution is to revert to being a lead arranger, but to then put 80 per cent of each deal in its fund, while keeping some “skin in the game” by retaining the remaining 20 per cent.
The European Commission and EIB are more exercised by the collapse of another funding model commonly used before the financial crisis; that of infrastructure developers issuing bonds that were guaranteed by so-called “monoline” credit insurers, such as Ambac and MBIA, allowing institutional investors to effectively outsource their due diligence processes.
The subsequent meltdown of the monoline sector means “such issuance practically came to a halt”, according to the Commission, with project companies generally unable to issue investment-grade bonds until they have completed construction of a project.
The EU and EIB are proposing a “credit enhancement mechanism” that would once again make project bonds attractive to risk-averse investors, with the two institutions instead sharing the risk of losses.
This mechanism could take the form of a debt service guarantee, essentially a credit line in the event of the developer being unable to service its debts. Alternatively, the EIB could make a subordinated loan to a developer, thereby raising the seniority and security of the debt bought by the private sector.
Of the 100 “stakeholders” that responded to a consultation exercise on the proposals, 60 thought the ideas would attract private investment to infrastructure debt, with only two saying it would not. However the Project Bond Initiative is unlikely to be fully operational before 2014, leaving the path clear for the new wave of debt funds in the interim.
Some fear slow-moving institutions will fail to seize the initiative. “The debt instruments investors buy are all rated instruments, but here we are in unrated instruments. [Investors] need to ... analyse it and all that can take three years,” says Hans Meissner, managing partner at Eiser Infrastructure, a manager of equity funds.
Fundraising has so far been patchy. Aviva Investors and Hadrian’s Wall Capital announced plans for a €1bn subordinated infrastructure fund in 2010, but are still trying to raise money. The Australian market has led the way. Melbourne-based Westbourne Capital has reportedly raised more than A$1bn (US$980m), while AMP Capital raised €241m at its first closing.
Although cagey about the potential returns, Mr Cooper says: “You are getting an increase in yield over what you would get from lending to local authorities or the government. It’s an attractive asset class.” Similarly, Mr Gardner foresees “a significant real return above long-dated inflation-linked gilts” for investors willing and able to take advantage of the “illiquidity premium” that comes with being prepared to tie-up money for a long period of time.
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Eric D. Schwerin
eschwerin@rosemontseneca.com

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