Infrastructure Debt Investment Q&A

Economic infrastructure refers to commercial assets and services that are essential to economic activity. These assets are typically, public, communal and/or broadly available, have widespread and stable end-user demand and carry high replacement costs.

Social infrastructure encompasses  assets such as healthcare, schools or government facilities. These often have government or public-sector counterparties and their revenues reward investors for the essential service provided rather than demand fluctuations.

Economic infrastructure can offer steady income returns with low pricing volatility and low levels of correlation to the economic cycle. It benefits from resilient underlying cash flows, hard asset-backing (where available) and the contractual protections generate attractive risk-adjusted returns.

Social infrastructure assets, which may have lower levels of operating performance variability, tend to attract banks, insurance companies and other institutions investing. They typically see lower levels of return and often utilise higher levels of financial leverage.

Infrastructure has shown clear resilience relative to broader credit markets, with loss rates typically less than half of that of broader corporate credit of a similar credit rating.

Economic infrastructure typically avoids the higher level of cyclical risk compared to sectors dependent on discretionary consumer spending, financial services, real estate, or resources.

Economic infrastructure may absorb a moderate amount of commercial risk, for example traffic flows for a toll road, user demand volumes for a fibre network or a healthcare asset, or reliance on there being a market for electricity off-take agreements for a renewable power asset.

A few infrastructure segments, such as container shipping or upstream oil and gas, can be very cyclical and are not suitable for a portfolio such as SEQI’s.

Infrastructure debt can be structured at different levels of risk and return – from senior debt to subordinated debt – and may take a variety of forms. SEQI focuses on a balance between senior, mezzanine loans and holdco loans, that depends on the nature of the industry sector, borrower and pricing. This strategy is designed to provide a mix of good credit security and attractive income.

• Senior debt has first lien rights over the borrower’s assets and cashflows if the borrower defaults on the loan.
• Mezzanine loans have a second lien on the cash flows and assets of the borrower.
• Holding company or “holdco” loans may be technically senior loans but are structurally subordinated to loans in place at any underlying operating subsidiaries. Such a loan, made directly to an operating subsidiary, would have priority security over the cash flows and assets of that subsidiary.
• Convertible debt or preference shares may be structured without meaningful underlying asset-based or cash flow security but rank ahead of ordinary equity in the event of borrower default on its liabilities.

Careful assessment of a broad range of considerations, for example, the industry sector, the competitive market position of the asset, the credit rating of the borrower, the loan-to-value of the proposed instrument, the use of proceeds, the use of guarantees, the structuring of ongoing financial covenants, and a host of other detailed considerations.

Private debt (broadly defined as private placement bonds and loans without a syndicating bank) is generally not traded on an open market. A lender in the private credit market may play a more active role in structuring and managing credit, with additional potential for enhanced returns derived from relative illiquidity and complexity, as well as intrinsic value from the provision by the lender of a tailor-made credit solution.

Public debt (broadly defined as public bonds or loans arranged by a syndicating bank and traded on an open market) can increase portfolio diversification and liquidity, and can enable investors to access a higher return on surplus cash in a portfolio.

The analytical skills required for both are largely the same, and experience in the listed bond market is an essential contributor to an investment management team’s up-to-date understanding of pricing and structuring.

SEQI focuses primarily on loans and bonds at the BB and B equivalent level, which represent the higher end of the credit quality range that is below “investment grade”. These credits offer a balance between higher investment yields and a moderate level of risk, which can be measured in expected default and loss rates.

SEQI does not focus on investing in credits at a CCC rating or below, which represent more substantial investment risks, often requiring work-out or restructuring where these loans default.