BNP AM

The sustainable investor for a changing world

Portfolio perspectives | Article - 4 Min

The resilience and diversity of infrastructure debt

Daniel Morris
2 Authors - Portfolio perspectives
04-06-2023 · 4 Min

For investors eyeing stable long-term income from a broad and diverse asset class, European infrastructure debt can be a resilient solution. It has been as robust in times of crisis – witness its performance during the pandemic – as it has been across economic cycles. What is its secret? Infrastructure provides services that are in demand whatever the economic climate.  

Rates, project costs and returns

We expect growth to lose some momentum in 2023. Europe will likely feel the drag from a contraction in the US. At the same time, the European Central Bank will feel the need to keep policy rates high over time to slow demand and thus contain inflation.

Higher interest rates not only mean higher (infrastructure) project financing costs, but also change the relative attractiveness of investments.

The gap between the dividend yield of eurozone equities (using on the MSCI EUM index) and 10-year German government (Bund) yields has fallen to its lowest since 2010, signalling a revaluation that also applies to fixed income alternatives such as infrastructure debt.

Infrastructure bonds – Solid features

Aside from the economic impact of the war in Ukraine, the attitude of governments and society towards energy security has changed. There is now more support for green energy. Policymakers have prioritised solar and wind power as well as green hydrogen. This focus should boost demand for essential – green – infrastructure. It highlights the solid fundamentals of infrastructure debt.

Infrastructure bonds benefit from longer-term dynamics. Demand for infrastructure services (which include power, water, telecommunications, and transportation), is relatively inflexible, meaning that price increases do not lead to big drops in demand and neither do economic downturns. Arguably, this lack of cyclicality rubs off on infrastructure bonds.

Moreover, infrastructure service pricing is often indexed. Investing in infrastructure can thus be seen as a practical inflation hedge (see Exhibit 1). We also note that infrastructure bonds typically have floating-rate coupons, tracking market developments. This adds to the stable value of the debt. Other features include the monopolistic positions of many service providers and the high barriers to entry for competitors. For example, one motorway between cities typically suffices, giving the toll booth operator a monopoly on that stretch of road.

Attractive investment opportunities

A key area is decarbonisation of infrastructure to help governments meet net-zero emissions targets. This includes car charging platforms, the electrification of rail travel and green mobility.

The demand for power is inevitably increasing, in particular for green electricity. We are seeing more financing transactions in areas such as biogas, distributed energy, energy efficiency and recycling.

Increasing renewables generation as well as distributed solar and green hydrogen involve capital spending on smart grids and upgrading transmission networks.

We are seeing a regular pipeline of opportunities in the healthcare infrastructure sector, boosted by post-pandemic demand and a scarcity of public money. The economy of the future will experience major demographic shifts. Greater rural-urban migration and population aging will drive demand for services such as healthcare or day care, or the deployment of fibre glass networks in rural areas.

Now more than ever, investors are looking beyond returns to the impact of their investments, financing projects that benefit the environment or local communities. Renewables are an obvious target. Challenges include measuring a project’s impact and ever evolving regulations.

Bond issuance has been expanding steadily as new infrastructure is built to keep up with technological progress and existing infrastructure is modernised. This broad and diverse market saw some EUR 310 billion in deal value in 2021 (latest data available); 70% was financed with debt.[1]

Infrastructure debt valuations

Competition and abundant liquidity have put pressure on pricing. There has been some repricing in sectors such as digital technology and energy. A scarcity of materials for greenfield projects or capital for renewables projects may impact business plans. However, an estimated USD 330 billion of dry powder from institutional investors supports the market.[2] We believe this should keep valuations stable.

We have now seen five years of strong fundraising, with 2022 a record year for capital raised for infrastructure. To what degree this continues will depend on the asset allocation plans of investors. During periods of high volatility and market uncertainty, investments often go towards high-quality assets with a defensive profile on one hand and to repriced high-yielding opportunities on the other.

Both are available in European infrastructure debt markets.

You may find investment-grade bonds[3] with a senior ranking at a yield of close to 5%. Other features include low volatility as well as bonds targeting ESG friendly projects. This segment offers diversification from traditional corporate credit.

Investors looking for higher yields can earn absolute returns close to those of core equity from subordinated infrastructure debt.

Market outlook  

Within private markets, infrastructure is the second-fastest growing area in terms of retail and institutional assets under management. Data provider Preqin foresees compound annual growth of more than 13% until 2027. The pipeline is particularly full for renewables projects. We’ll likely see more digital (telecom) transactions in view of the need for telecom towers and data centres.

Given the sustained infrastructure investment needs, and demand from asset allocators looking for a stable asset class with attractive yields, we believe the future for infrastructure debt is bright.

[1] Infranews & Inframation, October 2022  

[2] Preqin, December 2022  

[3] Equivalently rated based on internal ratings

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
Environmental, social and governance (ESG) investment risk: The lack of common or harmonised definitions and labels integrating ESG and sustainability criteria at EU level may result in different approaches by managers when setting ESG objectives. This also means that it may be difficult to compare strategies integrating ESG and sustainability criteria to the extent that the selection and weightings applied to select investments may be based on metrics that may share the same name but have different underlying meanings. In evaluating a security based on the ESG and sustainability criteria, the Investment Manager may also use data sources provided by external ESG research providers. Given the evolving nature of ESG, these data sources may for the time being be incomplete, inaccurate or unavailable. Applying responsible business conduct standards in the investment process may lead to the exclusion of securities of certain issuers. Consequently, (the Sub-Fund's) performance may at times be better or worse than the performance of relatable funds that do not apply such standards.
Private assets are investment opportunities that are unavailable through public markets such as stock exchanges. They enable investors to directly profit from long-term investment themes and can provide access to specialist sectors or industries, such as infrastructure, real estate, private equity and other alternatives that are difficult to access through traditional means. Private assets do, however, require careful consideration, as they tend to have high minimum investment levels and may be complex and illiquid.

Related insights

Embedding ESG into private debt can reduce risk and add opportunity
13:28 MIN
Market weekly - What to expect after the Great Pandemic of 2020 (podcast)
Daniel Morris
2 Authors - Portfolio perspectives
06-23-2020 · 2 Min
BNPPAM

In the U.S., this material is for Institutional use only – not for public distribution. This material is provided for educational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Reliance upon information in this material is at the sole risk and discretion of the reader. The material was prepared without regard to specific objectives, financial situation or needs of any investor.

These documents and video clips may also include information obtained from affiliated investment management companies within BNP Paribas Asset Management, the brand name of the BNP Paribas group’s asset management services. The documents and video clips are produced for informational purposes only and do not constitute: 1. an offer to buy nor a solicitation to sell, nor shall they form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. Any opinions included in these documents and video clips constitute the judgment of the author/ presenter at the time specified and may be subject to change without notice.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, and estimates of yields or returns. No representation is made that any performance presented will be achieved by any funds, or that every assumption made in achieving, calculating or presenting either the forward-looking information or any historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BNP PARIBAS ASSET MANAGEMENT USA, Inc. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

FOR INSTITUTIONAL AND FINANCIAL PROFESSIONAL INVESTOR USE ONLY. THIS MATERIAL IS NOT TO BE REPRODUCED OR DISTRIBUTED TO PERSONS OTHER THAN THE RECIPIENT.

BNP Paribas Asset Management seeks to integrate environmental, social and governance (“ESG”) factors into all of our portfolios as a means to mitigate certain short, medium and long-term financial risks, identify better long-term investments, and encourage more responsible corporate behavior. We will never subordinate our client’s interests to unrelated objectives. Certain issuers and industries are excluded from our actively managed portfolios based upon our view of their ESG performance and risk profile. As a result, we may pass up certain opportunities when these excluded issuers or industries are in favor. Due to significant gaps in disclosure regimes around the world, we may need to rely upon voluntary disclosures by issuers, which are often not audited. We therefore may not have consistent access to complete, accurate or comparable information about the ESG performance of our holdings. Please consult the applicable offering document for more information about the specific ESG strategy employed by each investment strategy since a given strategy may not have specific ESG guidelines, and investments are not limited to securities that are ESG compatible.

BNP PARIBAS ASSET MANAGEMENT USA, Inc. is registered with the U.S. Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended. BNP PARIBAS ASSET MANAGEMENT USA, Inc. is a registered trademark of BNP Paribas or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. © 2024 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

BNP PARIBAS ASSET MANAGEMENT is the global brand name of the BNP Paribas group’s asset management services. © 2024 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

To access insights from our teams worldwide visit:
BNP AM
Explore VIEWPOINT today