Infrastructure Debt: Asset Allocation Considerations

In the first of a two-part series, we examine the role of private debt in institutional investor portfolios. This first report looks specifically at infrastructure debt.

Key points include:

• Infrastructure assets typically have high barriers to entry, long economic lives, stable (often inflation-linked) operating cash flow, high capital value and operating margins, and a relative lack of sensitivity to the broader economic environment;
• We believe these stable cashflows afforded to debtholders allow more ability for leverage and hence return;
• Further, infrastructure junior debt tends to attract an unfavourable regulatory capital outcome for banks and, as a result, there is less competition for these opportunities, enhancing returns and making an efficient risk/reward opportunity for institutional investors;
• There is inflation protection both from traditional resilience of infrastructure assets as well as the floating-rate nature of the junior loan securities;
• As long-term assets and their potential to incorporate into the energy transition movement, the ability for these securities to align with ESG principles can be high; and
• Historical ratings demonstrate the strong credit qualities such as high rating stability, low default history and for senior and unsecured debt, high recovery rates relative to non-financial corporates.

Despite the limitations from lack of historical returns data, using proxies and our team’s long-run experience in the sector we believe:

• There is a consistent spread / premium for senior infrastructure debt relative to investment grade credit;
• Controlling for downgrade and default risk, we find a significant excess spread premium for junior infrastructure debt relative to other fixed income securities; and
• Through scenario analysis of the potential volatility of junior debt, we find it is likely to have an attractive Sharpe Ratio compared to listed equities.
• As investors look to broaden and diversify their exposure to private debt allocation, infrastructure private debt can serve an important diversifier for portfolios.

To read the second report in this two-part series, click here.