Today when we look at yield, we tend to see it only in absolute terms but when we compare the yield/equity risk ratio of debt and equity, debt remains attractive: it is less volatile, less risky and can provide a steady return over time. Moreover, security rights are provided in cases of default. The yield offered is thus linked to the risk, which is quite low. These assets still deliver – thanks to the illiquidity premium – an additional return of between 100 and 150 basis points over bonds rated in the same category.
Why interaction with banks is important
The infrastructure market remains firmly in the banking universe, with banks raising three-quarters of the funding against a quarter for institutional investors including debt funds. So to deploy our investors’ capital and access the best opportunities, we need to be agile in origination and work in partnership with the banks. Furthermore, it is important to note that when banks are involved, they do not necessarily have the same objectives as institutional investors. Banks easily accept prepayments, which is not necessarily in the interests of institutional investors wanting to invest over the long term and obtain regular cash flows.
However, if we were to limit ourselves to structured transactions solely for institutional investors or debt funds, we would miss out on most of the market opportunities. Moreover, the inflow of liquidity from institutional investors makes the margins and conditions for these operations very competitive. In this context, access to structured operations initially intended for banks allows us to access a risk/return trade-off that can be more attractive.
In terms of investment timeframes, we have been relatively quick: our team was created a year ago, our first closing occurred in December and we took approximately six months to build a first portfolio of six operations. We are currently working on a second closing.
Renewable energy in infrastructure projects is of growing importance
Renewable energy accounts for a third of our portfolio of infrastructure debts. This significant proportion is part of our desire to generalise the use of ESG criteria when selecting our investments. They are at the heart of our management approach. At BNPP AM, a platform dedicated to ESG strategy is used throughout all our investment management. Before investing, we discuss ESG criteria with our ESG analysts, who even have a veto. We are also working on these issues with an independent third party involved in measuring the environmental and climate impact of projects. These ESG elements are very important for our investors, as they too are seeking to develop this type of approach across their own management and are required to establish ESG reporting for their assets. We also monitor our investments annually in the light of ESG criteria.
Brownfield or greenfield assets?
In infrastructure debt, there is no J curve. However, despite everything, investors have less appetite for greenfield risk than for brownfield because of the issues inherent in project construction risks. That works out well: most deals now focus on brownfield infrastructure as project shareholders benefit from market liquidity, low rates and thus refinancing for their projects.
We are also seeing a lot of infrastructure acquisition financing in a market context where mergers and acquisitions in Europe are very numerous. We also encourage investors not to fear greenfield as a matter of principle. If the structuring is done well, these operations go very well. Indeed, at the time of structuring it is a question of measuring all possible risks, for example such a construction delay, and of contractually transferring them, in this case to the developer. In addition, the financial structure must be able to ‘absorb’ any degraded scenario. In our fund we invest both in brownfield assets and greenfield assets within certain limits.
Given the sophistication of this market, should institutional investors have in-house expertise or can they rely on management companies?
Having in-house expertise remains relatively burdensome in human and organisational terms as the risk analysis of this type of asset is not standardised. In addition, there is a need to have a middle/back office capable of managing the specific characteristics associated with this type of illiquid asset, such as the transfer of receivables and related collateral or drawdowns (the investments are sometimes made in several successive instalments).
Furthermore, the structuring of dedicated funds or structures adapted to investors’ needs or constraints takes time, and there is a need for significant in-house expertise to carry them out well.
Finally, beyond the cost of implementing in-house management expertise, sufficient capital needs to be deployed to achieve satisfactory granularity in a portfolio. Pooling positions via a fund remains an attractive way to diversify its position at a lower cost.
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BNP Paribas Asset Management (BNPP AM) launched two new European private debt strategies on infrastructure debt and real estate debt at the end of 2017. The infrastructure strategy invests in senior loans in the transport, telecommunications, renewable energy and conventional sectors, social infrastructure and environment. The real estate debt strategy includes senior commercial real estate loans: offices, logistics, shops, hotels, operating assets and non-standard. Our private debt & real assets management division manages over EUR 7.5 billion of assets, through a wide range of private debt investment solutions that fully integrate environmental, social and governance (ESG) criteria into their selection processes. This allows investors to have a concrete impact on the company, including the financing of property projects or infrastructure, while accessing investment opportunities that offer an optimum risk return profile.
*This article first appeared in Funds Magazine (9 July 2018)
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