While many parts of the economy had to shut down as the coronavirus pandemic raged, the lights stayed on, water flowed from taps and internet connections buzzed. The crisis has highlighted the importance of the underlying infrastructure and, as Karen Azoulay explains, it was a useful reminder of the solidity of infrastructure debt as an asset class.
Listen to the podcast with Karen Azoulay, head of infrastructure debt, or read the article below.
Infrastructure debt – A source of stable income and value
Investors are continuing to search for sources of income in the current low-yield environment marked by, for example, modest returns from equities and bonds, bringing to the fore the merits of an allocation to infrastructure debt.
This source of financing for large assets that provide essential services from airport facilities to waste water treatment has many appealing characteristics that could be summarised by durability.
Advantages for investors include high barriers to entry such as the large sums needed to build a power plant and regulatory limits on the number of toll roads in a country.
Prices of infrastructure services are often regulated, which on the one hand can be viewed as a drag, but is on the other hand, a source of stability when it comes to revenues. Price indexation protects to a degree against inflation risk. Finally, the technological risk of infrastructure is low.
For investors, infrastructure debt offers a liquidity premium, rewarding them for holding assets that typically cannot be readily sold and that require a long-term investment horizon (see exhibit 1). The upside is that the performance of these assets is as a rule uncorrelated to that of equity or bond markets, making an investment in infrastructure debt a valuable source of portfolio diversification.
Exhibit 1: Yield premiums of European infrastructure debt over equivalently rated corporate debt
Source: BNP Paribas Asset Management, Bloomberg. Corporate bonds: Average option-adjusted spreads by credit rating for non-financial corporate bonds. European infrastructure debt: Estimated average based on a sample of market observations; May 2021
The pandemic – The first true test of fundamentals
The resilience of infrastructure debt was highlighted during the pandemic, which marked the first major challenge since institutional investors began entering the asset class in 2012/2013. (Previously, this had been a market dominated by bank lending.) Our analysis is that infrastructure debt came through with flying colours.
Volatility in this market remained low and there was little impact on pricing. Admittedly, there were differences across the asset class: Transportation was hit hardest as mobility dwindled, but as economies reopened, toll roads, for example, experienced a rapid recovery and traffic returned to pre-crisis levels. Airports, however, may take longer to overcome the blow they suffered.
Clearly, there were areas that were unaffected or even benefited such as utilities and telecommunication.
Telecommunication is among those segments we see as holding particular promise for the future. In fairness, the rise of telecoms – and if we take a broader perspective, digitalisation – is a long-term trend already underway before the Covid crisis.
However, the boom in home working, ecommerce and online entertainment during the lockdowns can be seen as a precursor to more demand for (financing for) data mobility and connectivity infrastructure such as fibre networks, datacentres and telecom towers.
Equally, the energy transition should be great driver of infrastructure demand and this market should benefit from the strong political push for clean energy and ultimately a net-zero economy. We are talking about not only renewing existing energy infrastructure, but also financing the costs of utilities phasing out coal-based power plants.
A more recent trend, accentuated by the health crisis, is the rise in healthcare-related and other social infrastructure transactions. Areas include specialist care facilities, but also affordable housing, and recreational infrastructure such as sports facilities and even amusement parks.
Resilient by nature
The quality of the asset class and its ability to generate stable income irrespective of market conditions should ensure that infrastructure debt is well positioned to perform in the coming years. The asset class is poised to benefit from strong tailwinds driving demand for infrastructure for the net-zero, digital economy of the future.
Moreover, the infrastructure market should continue to require more financing for projects that provide essential services. Given this positive outlook together with the core fundamental strengths of the asset class, we believe infrastructure debt looks set to remain an attractive investment opportunity.
For a comprehensive view of the role European infrastructure debt can play in the post-Covid era, read European infrastructure debt: Resilient and essential in the post-Covid environment written by Karen Azoulay, head of infrastructure debt and lead manager of the BNP Paribas European Infra Debt Fund, a multiple award winning sustainability fund.