The optimal balance.
Infrastructure bonds. The market for interest rate investments is split in two. Completely safe securities no longer offer a yield. And where investors can achieve high returns, the risk of bankruptcy is always present in the face of the looming global recession. The Schroders investment house has found a middle ground. Infrastructure bonds can generate yields of around four percent - with a maximum of security.
"Actually, our consideration was quite simple", explains Peter Begler, Director Alternatives at Schroders, "we asked ourselves which area of the economy was least affected by possible macroeconomic turbulence and inevitably came across the infrastructure sector".
Infrastructure is the backbone of our economy and society. Telecommunications, transportation or utilities - their services and products are always needed.
"What is particularly important now in the midst of the Corona crisis - the private operators there will most likely continue to service their bonds and repay their debts in the future. To illustrate the investment idea, Begler gives an example: "Imagine the operator of a district heating network in a major European city issuing a bond. It has a seven-year term, a yield of around four percent. Thanks to long-term contracts, he has a kind of monopolistic position in his field, which is indispensable for living together in the big city. So the sales are secured. And in order to meet its credit obligations, the network operator only needs a small percentage of its annual profit before interest and taxes. I find it hard to imagine that such an investment would become non-performing."
It is precisely such investments that Begler is looking for for Schroders' infrastructure bond strategy. "By then combining the securities of more than 10 different issuers, we provide diversification and add an extra layer of security".
Schroders is thus taking a new approach to infrastructure investments. Until now, this asset class has been made available to investors primarily through equity investments - equities or direct investments. "But there are already many providers there. A lot of liquidity is chasing the few particularly attractive investment opportunities," Begler informs. According to the data provider Preqin, the "dry powder" in 2018 actually added up to around 160 billion euros. "This ruins prices and lowers returns."
By contrast, the market for infrastructure bonds is relatively small, young and unknown. "This is an interesting route for companies because they can improve their return on equity by raising debt capital. And for us as investors, it is attractive because it gives us a very unusual relationship between opportunity and risk. We earn just a little less than the equity investor, but if the worst comes to the worst we are much better protected," says the infrastructure expert.
Basically, three sectors can be distinguished. The first is private placements with maturities of more than 20 years. However, it is reserved for institutional investors. The other two segments are important for private investors. Number two are senior bonds. They have maturities of about ten to twelve years and offer yield spreads in the range of 200 basis points. Those who take a little more risk are amply compensated for this in the third sector - the subordinated bonds. This is because these junior bonds yield around five percentage points with a maturity of five to seven years. "Compared with other segments of the interest rate market - corporate bonds, high-yield bonds or private debt, i.e. the direct granting of loans to companies - this is very attractive," Begler judges.
Indeed, analyses had shown that not only was the probability of default significantly lower for infrastructure junior bonds than in the even more profitable private debt segment. "The so-called recovery rate, i.e. what remains for the creditor in the event of default, is also much higher," explains Peter Begler.
This is also understandable. After all, many infrastructure assets are essential to our daily lives. "They cannot simply replace a district heating network, a road or a fiber optic line. Even if the operating company were to get into financial difficulties, investors would still have access to a real, long-term asset for the infrastructure property in question," Begler summarizes.
Because Schroders invests primarily in the higher yielding subordinated bonds, a very deep analysis of the issuer as well as the project is important. For this purpose, the investment house can rely on a team with many years of experience and high expertise in the infrastructure sector. For example, the Schroders investment team not only analyses the capital structure of the company, but also all technological, operational and construction risks.
They also pay attention to ESG criteria in their choice of paper in order to reduce risks that could result from unsustainable behaviour. "And through this investment we aim to make a positive impact on one or more of the 17 UN development goals."
As a matter of principle, Schroders concentrates on already existing facilities. "With new projects we would get a higher return, but the risks are much higher," explains Begler. The focus is on basic infrastructure facilities such as the supply of water or electricity, renewable energy, modern communications such as fibre optic networks and new mobility concepts.
The euro zone is currently particularly attractive for such a strategy. "This is not only the largest market in the world for such investments. Above all, we can also avoid currency risks here", explains Begler. A sufficient diversification according to countries and industries is also possible.
"None of us knows how the economy will develop next year," summarizes the infrastructure expert, "but if we can now - in the eye of the storm - secure four to five percent returns in a stable area that is less susceptible to economic cycles, then we must take advantage of this.
Infrastructure - a fascinating asset class.
The European infrastructure market is one of the most attractive in the world. The transaction volume in the brownfield sector - i.e. already existing projects - has averaged around 124 billion dollars per year in recent years. For greenfield, new facilities, the figure was just under 62 billion dollars. That is more than in any other region of the world. The market also offers the opportunity for broad diversification by country and sector. Sectors include renewable energy, telecommunications, environment and transportation.
Schroder Investment Management
(Europe) S.A., German Branch
Taunustor 1, 60310 Frankfurt
Christian Windolph (069/975717130)