Duncan Lamont, CFA, Head of Research and Analytics
Schroders’ third annual Institutional Investor Study analyses the investment perspectives of 650 institutional investors from 20 locations across the world.
In an environment where interest rates are rising or predicted to rise, investors have begun to consider the impact of such an environment on their investment portfolios, including infrastructure investment. Many may perceive that infrastructure equity will be better positioned than debt in an environment of rising rates but our research shows that this is not necessarily the case.
With dry powder for infrastructure equity investment at an all-time high, project sponsors have had to become more conscious of financing costs for projects in an attempt to reduce costs to bolster equity returns. With this, we have seen the junior debt segment of the market becoming used more frequently to create more efficient funding structures, creating a unique opportunity for investors to access core infrastructure assets with a compelling risk/ return profile.
The current high valuation of public assets is making it difficult for defined benefit pension schemes to balance their need for excess returns with the risks necessary to obtain them. Investing in less traditional assets like infrastructure debt provides, we believe, an excellent way to balance these risk and return requirements. Furthermore, we argue that infrastructure debt is a particularly attractive component of cashflow driven investment (CDI) solutions, given its maturity profile and reliable performance even in stressed scenarios.
The current high valuation of public assets often makes it difficult for many investors to balance their need for excess returns with the risks necessary to obtain them. Investing in less traditional assets like junior infrastructure debt provides, we believe, an excellent way to balance these risk and return requirements.
Arguably infrastructure investing has been compatible with ESG, even before ESG was recognised as a term. Due to the private nature of the investments and the long-term holding period, sustainability from an environmental, social and governance perspective has always been important to understanding risk. In particular, the Schroders infrastructure debt scorecard analyses 48 micro risk criteria, 13 of which specifically relate to ESG. For our clients this means ESG will systematically be considered, rated and incorporated into every investment decision for each investment we consider.
The UK has for many years been heralded as a treasure trove of investable infrastructure assets. Core infrastructure equity has been generating double-digit internal rates of return (IRRs) and there has only been one instance of an A-rated UK infrastructure bond defaulting, over a 34-year period (versus 10 in the US). However, sceptics fear that may be coming to an end on the wave of some recent developments.
Interest rate risk for fixed-rate instruments: Interest rate volatility may reduce the performance of fixed-rate instruments. A rise in interest rates generally causes prices of fixed-rate instruments to fall.
Deterioration of the credit quality of the bond: Caused by a change in the market environment (for commercial activities) or a change in law/regulation (for all infrastructure activities).
Risk of issuer default: A decline in the financial health of an issuer can cause the value of its bonds to fall or become worthless.
Prepayment risk: The capital may be repaid by the borrower before reaching maturity.
Exchange rate risk: Where assets are denominated in a currency different to that of the investor, changes in exchange rates may affect the value of the investments.
Illiquid and long term investment risk: Due to the illiquid nature of the underlying investments, an investor may not be able to realise the invested capital before the end of the contractual arrangement (which is likely to be long term). If the investment vehicle is required to liquidate parts of its portfolio for any reason, including in response to changes in economic conditions, the investment vehicle may not be able to sell any portion of its portfolio on favourable terms or at all.
Capital loss: The capital is not guaranteed and investors may suffer substantial or total losses of capital.
Trade cancellation risk: Trades and settlements are made on a bilateral, negotiated basis. A last-minute trade cancellation can occur in the absence of standard trade and settlement processes via clearing houses.
Service provider risk: Investments can be at risk due to operational and administrative errors, or the bankruptcy of service providers.
Please remember that the value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
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