Debt strategies might be the next big thing in the young infrastructure asset class.
Funding pressures on banks, which hold the vast majority of this debt, could induce them to sell, and some experts say pension funds and insurance investors are naturals to be holders of this long-term debt.
RREEF Infrastructure plans to unveil a new debt strategy in the first quarter of 2012, and J.P. Morgan Asset Management announced in November it was getting into the space.
Still, interest in infrastructure debt is more of a spark than a blaze, some experts say. There's some question as to whether it will ever catch fire among institutional investors.
The £2.3 billion ($3.6 billion) East Riding of Yorkshire Council Pension Fund, Goole, England, committed €12.5 million ($17 million) to AMP Capital Investors' Infrastructure Debt fund in November. It was East Riding's first infrastructure debt investment in its £40 million infrastructure portfolio. “In terms of our portfolio, we thought it was a good addition to the mix,” said Ian Sandiford, senior portfolio manager.
The AMP fund has raised €284 million and is targeting €500 million, according to Andrew R. Jones, global head of infrastructure debt at AMP Capital.
The largest infrastructure debt fund in the market is Aviva Investors' Hadrian Capital Fund I, which is targeting £1 billion, according to Preqin. Hastings Funds Management and Sequoia Investment Management Co. Ltd. are each raising e1 billion funds, while Cordiant Capital Inc. is raising a $1 billion fund.
As of Sept. 30, 16 infrastructure debt funds were seeking a combined $8.8 billion in investor commitments globally, according to data from research firm Preqin Ltd. By early December, there were 19 funds seeking $12.2 billion. Further increases are “certainly something we envisage continuing in the future,” said Iain Jones, research analyst in infrastructure at Preqin in London.
“There is a growing interest in the (institutional investor) market, and banks are retreating — and will continue to retreat — because of regulations around Basel III,” said John McCarthy, managing director and global head RREEF Infrastructure, London.
Basel III is a set of international banking regulations yet to take effect; the new rules are expected to prompt banks to unload long-term debt holdings. “There has to be a way of filling that hole. Infrastructure funds are a way of doing so,” Mr. McCarthy said.
RREEF has a debt team in place and is looking at possible strategies. A new product is planned for early 2012, but Mr. McCarthy declined to provide further details.
Meanwhile, JPMAM is creating an infrastructure debt investment team under the leadership of managing director and portfolio manager Bob Dewing. Based in New York, Mr. Dewing will coordinate the firm's expertise in credit and real assets.
“We're bringing together two different skill bases: the skill to analyze fund infrastructure risk and ... a very large fixed-income platform that manages many billions of dollars,” he said. “It's unusual to bring both skill bases together.”
However, Luba Nikulina, senior investment consultant and global head of private markets, Towers Watson & Co. in London, isn't convinced that infrastructure debt will take off among institutional investors, and cites a couple of reasons for hesitation.
First, investors need a fund or manager to bundle together these debt assets, and costs have been high. “There are a lot of funds being raised now in the market, but they tend to be expensive. They borrow their fee structure from the private equity world rather than the fixed-income world,” she said.
Also, it's not clear why infrastructure debt would be run as a separate asset class. “The question is: Why would you allocate to infrastructure debt as a separate allocation as opposed to a wider allocation across many (debt) strategies?” Ms. Nikulina said.
“It will probably be another two to three years before the future of infrastructure debt is clear,” she said.
Georg Grodzki, head of credit research at Legal & General Investment Management, London, said: “There is growing interest out there, but this has not yet translated into major investment flows from U.K. pension funds or retail investors.” LGIM runs about £1 billion in infrastructure debt for its insurance parent.
Mr. Grodzki said infrastructure bonds are a “natural fit” for pension funds and insurance companies with long-dated liabilities because the bonds are “long-dated, often linked to inflation, and their credit quality is less sensitive to fluctuations of economic activity than other bonds.”
However, much of the infrastructure debt held on banks' balance sheets would not be attractive to institutional investors, Mr. Grodzki said, because it tends to be floating rate, shorter-dated and not always investment grade. “Very little of their loan portfolios is of interest to us. You would have to re-engineer them, which is expensive and laborious.”