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Infrastructure financing - an overview

Infrastructure assets support economic growth by delivering essential services and facilities that are difficult to replicate or replace. The relatively stable cash flows appeal to equity investors and also provide comfort to lenders, enabling relatively high levels of leverage (c.75% debt financing, on average).

From an investment standpoint, there are many different routes to accessing this market with wide variation in the risk and return profile of each.

Listed infrastructure equities may at times outperform the broader market in absolute or risk-adjusted terms but these investments are also exposed to the vagaries of broader market sentiment and returns are likely to remain highly correlated with equities. Given elevated equity market valuations, it is optimistic to expect much more than mid single digit returns from listed infrastructure equities at present.

Unlisted infrastructure equity offers greater diversification potential than the listed market but high levels of fundraising over recent years alongside too few assets coming up for sale have pushed prices up considerably. Expected returns for core infrastructure investments have fallen from the double digit levels of the past to as low as 6-8% now.

Infrastructure corporate bonds do not provide any noticeable diversification benefits or a structurally better risk/reward trade-off than can be obtained in similarly rated global corporate bonds. From time to time, they may offer the prospect of better absolute or excess returns than available elsewhere but such opportunities are tactical rather than structural. A yield of around 3% is slightly higher than offered by global corporate bonds but only on a par with bonds of equivalent credit risk.

Private infrastructure debt is a diverse market, covering a range of maturities (5-30yrs), payment terms (fixed/floating), credit risks (investment grade/high yield), regions and sectors, with Europe being the largest market for operational assets. A 1.0-1.5% credit spread pick-up is available over European public infrastructure bonds as well as additional covenants and security not normally available in public markets. However, the trade-off is in liquidity with investors unlikely to be able to access their money easily, if at all, until their investments mature. Credit spreads have held steady at 2% in the European core 5-10 year market and investors who are prepared to move further down the risk spectrum into the more specialised high yield market can earn spreads of over 4%. However, in the long duration (up to 30 year) sector of the market, excess demand has pushed up prices, lowered credit spreads and dimmed attractions. Credit spreads here have fallen to 1.5-2.0% and, although these assets continue to serve a purpose from a liability matching standpoint, they now offer far less appeal on a stand-alone basis.

In addition to a higher credit spread, infrastructure debt has also demonstrated lower credit risk than public bonds of similar credit profile. Credit losses on secured BBB-rated infrastructure debt have been closer to those on secured A-rated non-financial corporate debt than BBB. Furthermore, credit losses on BB infrastructure debt have been around half that of BB non-financial issues.

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