Investors looking to invest in assets that can stand the test of economic gyrations and come through crises such as the COVID-19 pandemic can find hope in the solidity of infrastructure debt – financial instruments used to fund projects involving large tangible assets such as power plants and roads, argues Karen Azoulay, head of infrastructure debt.
Developed market infrastructure assets have proven resilient in recent months since the services connected to them – electric power, clean water, internet access etc. – were felt to be essential in keeping societies functioning.
Infrastructure assets also often benefit from high barriers to entry – it takes many years and many millions, for example, to build a power plant and gaps in the markets cannot usually be filled at short notice. Often, they involve monopolistic positions and regulation – only so many bridges are needed or, as another example, once a utility services a given area, there is no need for another.
Such characteristics mean infrastructure assets can provide long-dated, high-quality cash flows across economic cycles. Investing in them means getting access to stable return potential.
Infrastructure debt – Holding up in many areas
During the height of the COVID-19 crisis, these features meant that the asset class was generally much less volatile than most other asset classes, equities included. With continued market volatility expected for the rest of the year as economies and societies battle potential second waves of the virus, we believe this is a characteristic worth remembering.
Among the infrastructure sub-sectors that proved most resilient were sources of renewable energy. Many of these were already operational (not being built in other words) and it was found that many could be operated remotely, i.e., without a need for staff to travel to the site to work there. They were deemed essential and accordingly they functioned without interruption.
Equally, many utilities ran unabated. Think of heating networks and water treatment companies. On the telecoms side, fibre optics networks and telecoms towers gained importance as remote working – and the need for the high-speed internet access – became the norm.
That said, some sub-sectors did less well. Take transportation. Toll roads saw a sharp decrease in volumes during the lockdowns as traffic dried up, but mostly recovered quickly to pre-crisis levels. Airports suffered the most, however, and could take several years to recover, particularly in light of structural challenges such as reduced business travel and tourism.
Shift in issuance towards sustainability
We believe that those sub-sectors that held up well, such as renewables and telecoms, should see more debt being issued.
The fact these sub-sectors are more compliant with sustainability demands and initiatives such as the EU decarbonisation plan should also support their development and demand for more capital.
Conversely, we expect transport to be less active in terms of issuance. We believe environmental, social and governance (ESG) factors will be influential in deciding where capital is directed.
Infrastructure debt and ESG
At BNP Paribas Asset Management, ESG considerations are a central part of how we invest. We have embedded an exhaustive ESG policy in our investment process. This involves an assessment by our internal Sustainability Centre, which can even veto investments. In addition, independent experts conduct impact assessments on aspects such as avoided emissions, net environmental contribution and alignment with the Paris climate targets. We combine these insights so that we can construct sustainable portfolios and use them for ESG reporting to clients.
An alternative source of returns
The net result is a class of ESG friendly investments with built-in stability such as steady cash flows that offers diversification with other, more traditional, asset classes as well as within the asset class itself depending on the sub-sector chosen.
As a further layer of diversification, we enable investors to invest in senior debt[1] with an attractive valuation thanks to its illiquidity premium and low expected loss and in junior debt with higher absolute returns and still invested in the same resilient underlying assets.
[1] In finance, senior debt is debt that takes priority over other debt owed by the issuer. It is a class of corporate debt that has priority with respect to interest and principal over other classes of debt and over all classes of equity by the same issuer. Source: https://en.wikipedia.org/wiki/Senior_debt
Also read:
Responsible infrastructure investment: more than just renewable energy
