Senior infrastructure debt. Investment Case KPMG Investment Advisory Credit Research January 2019

Transcription

1 Senior infrastructure debt Investment Case KPMG Credit Research January 2019

2 Senior Infrastructure Debt Inv Executive Summary KPMG View We believe the long term inflation linked cashflows that senior infrastructure debt provide make it a particularly attractive investment for some investors, especially as part of a Cashflow Driven Investment ( CDI ) strategy. Although returns are relatively low compared to other illiquid assets such as direct lending, the essential nature of the underlying asset, along with the protective covenants and seniority in the capital structure provides sufficient downside protection. Clients should take into consideration the illiquidity and high concentration in pooled funds. We recommend an allocation of 5-10% of total assets. estment Case What is it? Infrastructure refers to a broad range of physical or organisational structures that are vital for modern economies to operate. Examples include Heathrow airport and the M6 motorway. Infrastructure debt involves lending for the construction/expansion, refinancing or purchase of infrastructure assets. Senior debt sits at the top of the capital structure. In the event of default it will have first claim to the asset. Example Assets Airports Hospitals Telecommunication Towers Why senior infrastructure debt? Contractual Returns The focus on income provides greater certainty of returns under a broad range of economic scenarios. Inflation-Linked A significant portion of underlying loans are linked to CPI or RPI providing a natural inflation hedge. Illiquidity Premium Offers an attractive risk-adjusted return over investment grade corporate bonds due to the inherent illiquidity of the underlying loans. Low Default Risk: Historically low defaults due to the essential nature of the assets and risk protections. Target Return (net of fees): Gilts + 1.7% Fund Structure: Closed ended Asset Concentration: 5-15 assets Fund Term: Typically 25+ years Typical Fee: 0.25% 0.55% Geography: UK How does it fit in to your portfolio? Cashflow Driven Investing CDI strategy: The long term contractual cashflows and lower risk of senior infrastructure debt fit well within a CDI strategy. Diversifier: Low correlation to traditional asset classes, corporate real estate risk and low GDP linkage can provide genuine portfolio diversification. ESG: Infrastructure assets help build and develop communities and economies, for example hospitals and educational facilities which aligns well with responsible investing. What are the key risks? Political/Regulatory: Given the monopolistic nature of the underlying businesses, assets can often be heavily regulated which exposes the cashflows to political risk. Asset Specific Risk: Infrastructure assets are inherently different and are exposed to varying levels of credit, operational and technological risks. Concentration Risk: The size and cost of infrastructure assets means portfolios are more concentrated compared to other alternatives.

3 Summary: Senior infrastructure debt involves lending for the acquisition, construction, expansion or refinancing of infrastructure assets. Debt repayments are financed through a combination of underlying demand based revenue streams and/or government contracts. Due to the size and cost of infrastructure assets, funds are concentrated with typically 5-15 assets. However, managers look to diversify across sectors and underlying revenue streams. Senior Infrastructu What is it? Utility and Energy Provision or transportation of essential services such as water, gas, electricity. Power generation Revenue Stream: low risk, regulated re Debt Investment Case Sector of underlying assets Communications TV, telecoms and broadcasting towers Data centres Revenue Stream: regulated, but often entail demand risk³. 1 Social Infrastructure Education, medical and correction facilities Community and sports facilities Revenue Stream: exposed to demand risk by usage Transportation Related Rail, toll roads, bridges, tunnels Airports, ports, parking Revenue Stream: exposed to demand risk by usage Key characteristics 2 KPMG return assumption Gilts + 1.7% Fund term +25 years Geography U.K. Fees % Management Inflation linkage 40-80% No Performance Fee No. of 5-15 positions Brownfield/Greenfield* Predominantly brownfield 10% Fund currency GBP 0% 100% Senior debt positions will typically make up the majority of 90% the capital structure (50-70%). 80% Capital structures will vary by 70% Senior asset. Junior Equity Source: Investment Managers. 1.Note exclusive to these sectors only. 2.The information shown is indicative only. Due to the wide range of strategies within the asset class there is no guarantee that these exact characteristics will be achieved. Final asset allocation could be significantly different. 3.Demand risk: the success of certain projects or assets may depend on the demand from consumers. *Brownfield assets: mature projects that are already in operation. Brownfield infrastructure is considered to be of lower risk, as projects are already operating and provide a reliable stream of cashflows. Greenfield assets: projects which are still in the development stage. Greenfield infrastructure is often associated with a higher risk, as the investor may be exposed to the construction risk of the asset, so there is less certainty of the outcome. 60% 50% 40% 30% 20% 3

4 Summary: The opportunity provides a good level of certainty over the long term return which can be used to meet investors ongoing cashflow requirements. The illiquidity associated with the asset also results in a pick up over similarly rated corporate bonds. The essential nature of the assets, combined with strong risk protections and seniority in the capital structure results in low expected loss rate compared to similarly rated corporate bonds. Senior Infra Why senior structure Debt Long term inflation linked cashflows Long dated (25 years +) GBP cashflows with 40-80% inflation linkage. Yield pick up over similarly rated corporate bonds Investment Case infrastructure debt? Attractive risk adjusted return Return pick up of bps over BBB corporate bonds with single A rated risk. Expected loss (10 yr cumulative) Diversification Underlying risk drivers differ from traditional corporate, real estate and residential risk. Basis Points Source: Sample manager 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Aa IG Infrastructure A Baa Source: Global Infrastructure Hub, Moody s, Investment Managers Why now? Increased regulatory pressure in the banking sector has reduced their ability to make long term loans. The McKinsey Global Institute states that the world needs to invest an additional 3.3tn annually just to support current rates of growth through to Source: Global Infrastructure Hub Document Classification: KPMG Public

5 Summary: Investors need to consider whether they are comfortable taking on the illiquidity and other risks associated with senior infrastructure debt investments before making an allocation. As with any other investment, there are risks associated with infrastructure. Emphasis should be placed on selecting managers who have demonstrated an ability to deploy capital and manage risks within this space. Senior Infrastructure Debt Investment Case Key risks Political/Regulatory Infrastructure plans are often initiated by governments. Assets are also monopolistic in nature. Therefore assets are exposed to any changes in regulation and government intervention. Asset Specific Risk Typical risks include: Credit Risk There is the risk that the sponsor (equity holder) may default on debt repayment. Operational Risk The asset is run by the equity holder and is subject to their skill in running the asset efficiently. Technology Risk - Specific assets may be subject to rapid technology advances and could become obsolete. Construction Risks A relatively small amount of investments may can be exposed to this risk. Greenfield (assets in construction) Risk through securing of permission, cost overruns and any unexpected expenses. Concentration Risk Typical exposure to an asset within a fund is c.10% compared to c.4% in direct lending funds. Illiquidity Risk Underlying investments are inherently long term, disinvestments before fund expiry will likely result in receiving a reduced price. Mitigations: 1. Documentation: Better protection is based on the managers ability to negotiate strong covenants. (Covenants are the terms and conditions that govern the actions of the debtor) 2. Diversification: The UK market is the largest in the world, representing approximately 42% of infrastructure deals in Europe over This allows for sufficient diversification across sectors. 3. Manager skill: The manager will undertake a thorough due diligence process and risk assessment. All risks are stressed in a scenario analysis before the investment in made. We target managers with strong track records, a focus on ESG, robust risk management processes and workout experience. We also target funds that have guidelines for brownfield investments, preventing excessive construction risk. Source: Investment managers Geographical Risk Investments are only in UK infrastructure assets which can pose a risk if the geopolitical landscape or sourcing channels are affected. 5

6 Ajith Nair Benjamin Finestein Rav Sangha Daniel Sykes Head of Manager Research Head of Private Credit Research Assistant Consultant Assistant Consultant Tel: Tel: Tel: Tel: kpmg.com/uk The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International The KPMG name and logo are registered trademarks or trademarks of KPMG International. CREATE: CRT Document Classification: KPMG Public