At present, there is a great deal of interest in real assets, including Infrastructure debt. This asset class offers institutional investors various advantages, such as a more favorable return-risk ratio than liquid corporate bonds. More than half the projects currently relate to the energy transition. In addition to knowledge and experience, the manager must also be flexible to respond to the specific objectives of the investor. An interview with René Kassis, Managing Director, Head of Private Debt at LBPAM (La Banque Postale), in which Aegon Asset Management is a shareholder.
How can we define the Infrastructure Debt asset class?
'We are talking about assets that provide essential public services such as transport, energy, hospitals, utilities and telecom infrastructure. We also include companies that tackle environmental problems, e.g. water treatment and minimizing energy wastage. In the long term, these assets generate predictable and stable cash flows. Whatever the position in the economic cycle, people have to drink water, move from one place to another, etc. Furthermore, the investments are always based on solid legal contracts. The infrastructure environment is often regulated and there is hardly any volatility in the returns. These are assets that have been set up, are owned by and are managed by renowned private sponsors on behalf of the public sector.'
What is the investment proposition for institutional investors?
'The most important argument is diversification within the bond portfolio. Infrastructure debt is usually part of a wide-ranging credits or investment grade strategy. A traditional credit mandate consists of liquid bonds. Infrastructure debt is illiquid. There is no organised market, the loans and bonds cannot be found on Bloomberg, and have – exceptions aside – no rating. In the case of infrastructure debt, investors receive an illiquidity premium. That premium is roughly 1%, but it varies over time depending on the specific strategy and objectives. All in all, there is a favorable risk-return ratio. Infrastructure debt is characterised by long durations supported by long-term revenues and contracts. Infrastructure debt is therefore an effective match for long-term liabilities. Finally, there is the ESG aspect. The character of infrastructural projects means that they automatically meet the sustainability criterion. The businesses involved provide essential social services. An increasing portion of Infrastructure debt involves businesses active in the environmental sector and the energy transition. Partly as a result of the current political agenda, more than 50% of the investment projects that we invest in are now related to these areas.'
The most important argument to include infrastructure debt is to diversify a bond portfolio. It's usually part of a wide-ranging credits or investment grade strategy.René Kassis
What is the situation regarding ratings?
'We place Infrastructure debt in the low investment grade class. Some investors explicitly request ratings, because this is part of their investment plan. But most investors have no problem in doing without ratings. There is enough evidence and research to prove the investment grade class. Moody's studied thousands of these type of projects over a long period and came to the conclusion that the default rate equalled more or less a BBB credit portfolio. Moody's repeats this study every few years and the conclusion is always the same. However, although the default rate may be similar to that of liquid credits, the recovery rate is higher, because these are real assets with underlying solid legal contracts. Senior secured debt is customary. In the case of liquid corporate bonds, the recovery rate is around 40%, in the case of Infrastructure debt, it is around 80%.'
As regards the good matching for the long-term liabilities, aren't we talking mainly about loans with floating rates? Isn't that a downside?
'Up until about five years ago, Infrastructure debt was traditionally a banking market. Banks do indeed prefer to issue loans with a floating rate, i.e. Euribor plus spread. However, in a growing part of the market, where an increasing number of institutional investors are operating alongside banks, fixed coupons exist. But to be fair, floating rates still dominate, which does offer some protection against rising interest rates.'
What is the best way to invest in Infrastructure debt?
'It depends on the wishes of the client. The most common form is a closed-end fund in which several investors participate. However, some investors demand a customised strategy, which allows them to impose their own criteria and restrictions. This can take the shape of a fund or a mandate created specifically to fulfil the investor's own requirements. Some investors do both. They invest in a fund and have their own mandate. We manage both funds and specific mandates for our clients. The average term or life span of the funds or mandates we manage is between 10 and 12 years. The individual loans have a maturity of 5 to 35 years. The term of a fund is equal to the length of the loans with the longest maturity, because they have to be repaid eventually. In the case of long loans in particular, we have to be very selective when investing. These are illiquid products for which there is, in principle, no exit, so that an investor has to be certain that the cash flows generated on the underlying investments will repay the debts. Knowledge and experience are vital during the selection.'
Source: LBPAM - Aegon Asset Management
What skills are required when managing an effective lending portfolio?
'In our team, average experience is at least fifteen years. Most of the team members have project finance experience in a banking background, because, as I said, infrastructural companies were previously financed by banks. We are often asked why we are good at this, and in answering we point to the organisation and the investment team. Both are important. Let's start with the organisation. Given the long-term nature of the investments, the investor has to be sure that the manager is there for the long term. LBPAM has been in existence for years. We manage more than €200 billion and have two very committed and renowned long-term shareholders: La Banque Postale, which is owned by the French government, and Aegon. And now for the team. Knowledge and experience are vital. As regards the composition of the team, we work only with senior staff. We also believe in regional representation. We consider this to be a typical investment class where geographical spread has to be applied. We have a pan-European strategy. To find the right investments, the manager must be able to tap into sectors and countries where not all other major investors are active.'
And isn't flexibility a requirement to invest in various types of bonds of differing size?
'I agree entirely! Flexibility in terms of investment formats is key to implementing a strategy efficiently and to meet the needs of investors. At the end of the day, it all comes down to the client's risk-return objective, the form should not be an obstacle. We can invest in both bank loans and senior secured bonds, as well as in floating and fixed rates. We also have access to both green and brownfield projects. A good mix has to be achieved. We also have a local presence in Europe, which is important for concluding deals. In addition to the larger transactions, there must also be the flexibility to invest in small and mid caps, the less crowded trades, which results in a small cap premium.'
René Kassis hosted a webcast on the potential of infrastructure debt in an alternative fixed income portfolio. The playback of the webcast is now available for playback.