Building Up Assets
Infrastructure debt fits insurers’ portfolio needs, providing uncorrelated, investment-grade holdings especially attractive with an economic downturn looming.
- Jeff Roberts
- September 2019
PRIME EXAMPLE: The Cheniere Sabine Pass LNG facility in Louisiana represents the type of core infrastructure asset insurers are looking to invest in.
Photo Credit: Kim Brent/The Beaumont Enterprise via AP
- $50B: About $50 billion in infrastructure debt deals are completed each year in the Americas, but only about $5 billion in the institutional market.
- Safe Havens: Infrastructure debt offers investment-grade, fixed rate assets that are long dated and particularly attractive in periods of downturns because they are largely uncorrelated.
- Quality Assets: About 40% of infrastructure debt is investment grade.
The initiative was designed to fill a need. Allianz Global Investors wanted more diversity in its fixed income portfolio for its insurance clients, especially at the long end. But it found “precious little of it out there,” said Paul David, its director and head of Americas, infrastructure debt.
“When we looked at the universe of investible long-duration opportunities, there's only a limited number of names out there that you feel comfortable with,” he said. “We identified infrastructure debt as a good matching asset, but we just weren't seeing any coming.
“Hence we thought, 'Should we go out and try to do this ourselves?'”
So in 2012, Allianz Global Investors formed its own infrastructure debt team based in London and focused on Europe. David was one of its five original members.
Soon the in-house investment and origination unit expanded to take on third-party clients as the asset manager realized other institutional investors—especially insurers—were seeking similar solutions.
David outlined the rising opportunities in infrastructure debt, especially in the energy sector, and why the asset class is ideal for life companies in a recent interview with Best's Review. He spoke shortly after his team completed a $727 million deal in June with Cheniere Energy, which builds and operates natural gas liquefaction and export facilities.
The following is an edited Q&A with David.
Allianz Global Investors started with an infrastructure unit of five members. How big is the team now?
Globally it's 27. It's 18 origination people and nine people who assist in portfolio management and various other areas.
How did AllianzGI set its sights on the United States market?
We had to go out and create a market in Europe first. After a couple of years, we had succeeded in establishing ourselves there. Since it was a startup, we couldn't know for sure if we could make it happen, but it has happened. And then we wanted to see if we could do the same in the United States. So I put my hand up and said, “I'm interested.”
So I came over here to see what the opportunity was, and I realized there was a similar gap as in Europe. It wasn't being serviced by the institutional investor, and neither was it being serviced in particular by the insurance world. And with the firepower that Allianz has and its track record in infrastructure, I was able to get the ball rolling and get involved with a few deals.
Why are insurers interested in infrastructure debt?
It really is a natural fit for insurance companies to invest in long-duration, stable infrastructure—what we like to call core infrastructure. Here we're looking at opportunities with very stable cash flows, not subject to market risk. It's a natural asset class for insurance clients. Frankly, the client most suited is insurance companies.
Insurance companies want investment grade, fixed rate and they want really safe assets. Infrastructure is fixed income. It is long dated. They are safe assets.
It really is a natural fit for insurance companies to invest in long-duration, stable infrastructure. Here we’re looking at opportunities with very stable cash flows, not subject to market risk. Frankly, the client most suited is insurance companies.
Allianz Global Investors
How big is the infrastructure market?
The infrastructure debt market is very much dominated by banks. That's principally because within the infrastructure space, most of these issuers are one-time issuers. It's not all that easy for them to access the public market. So they tend to go to people who they can negotiate with on a one-time basis. And the institutional market is not really set up for that. We're trying to change the landscape.
There's about $50 billion in deals done every year in the Americas. About $5 billion is done in the institutional market and $45 billion done in the bank market. We're trying to change the way things get done. We're trying to move that so $10 billion of the $50 billion is done in the institutional market. Predominantly those in the institutional market are insurance buyers. We've taken on our fourth third-party client. All four clients are insurance clients, three of them are in North America and one is Korean. So it's beginning to gain momentum.
Perhaps 60% of infrastructure debt is non-investment grade. So that reduces the investible universe to maybe $20 billion of the $50 billion.
There are others trying to do it. For us, it would be really good if more institutional investors start to do what we're doing because it will mean there's more of a market and a natural go-to place for borrowers.
How much business does AllianzGI do annually in infrastructure debt?
Globally, we've done 66 transactions, and we've invested $16 billion in those 66 transactions. In the U.S., we've done about $4.5 billion. In Latin America, we've done about $1 billion so far. We've been pretty active here. Our focus is on big-ticket direct investing. We've made 18 investments, so about five deals a year at an average size of $300 million.
Why is supply not meeting demand for institutional investors?
The lack of product that has made its way to the insurance industry largely comes down to this: It's really quite hard for one-time issuers—and most of these are one-time issuers—to use an agency market place. The public agented marketplace tends to be full of these repeat issuers. Single issuers are just not a natural fit for that market. That's why it's been dominated by banks.
The lack of deal flow really comes down to a lack of people within institutional organizations who are prepared to roll up their sleeves, behave like banks and knock on the doors of borrowers and get these deals happening. It's about having a team skilled in structuring deals and going out and originating. There's a big pie, but the proportion that's come to the institutional market is very small. The goal is to try to widen that. You really need size and infrastructure pedigree to compete in this sector to be taken seriously by borrowers. Others looking to play in the same space as us? You've got MetLife. You've got BlackRock. IFM. Macquarie. That's about it.
It's really hard to get into the space. You need to find a platform that can take your capital and add it to other people's capital to get the firepower needed to secure deals.
A lot of our success has been down to our ability to write big tickets. Three of our deals have been $700 million or more. These platforms need to develop and need to accumulate these small-to-medium insurance companies onto their platforms to enable us to write these large tickets. A typical third-party client is looking to invest $15 million to $30 million per transaction, which is too small to work bilaterally with borrowers, but fits well within an established direct origination platform already investing large tickets.
Besides offering long-duration, investment-grade assets, why do your insurance clients like infrastructure debt?
They like it because for the same rating, the probability of default over the long term is probably less than half of what a corporate is. In fact, our view is over a 20-year horizon, BBB-rated infrastructure not only outperforms BBB corporate debt, but it outperforms even A corporate debt in terms of probability of default. Over a three-to-five year horizon, it's probably very similar to corporate BBB.
There are other things as well. There's plenty of evidence to say that in the rare instances when infrastructure does default, the loss given default is much lower. Rating agencies indicate that it's about an 80% recovery, or only a 20% loss given default in infrastructure. Whereas in typical corporate unsecured, it's about 50% to 60% loss given default.
The other benefit is correlation. It's a very uncorrelated asset class. It gives investors diversity, but without correlation. It is a subset of corporate fixed income. But from a credit perspective, it's a very idiosyncratic asset class. It doesn't tend to default. It's uncorrelated to the wider economy. Solar farms in Nevada are unrelated to wind farms in California or a road in Indianapolis or a gas pipeline in Texas.
It's a very defensive asset class, particularly at times when people are considering the end of the cycle. It's a defensive asset class because it's really not subject to market risk. People need electricity. People need water. They need to move from A to B. It's not something they can stop buying like the latest television set.
What kind of returns are we talking about?
Despite all these benefits, we think we can slightly outperform what you would get in the corporate universe. We would typically target a 50-basis point pickup over corporate in the U.S. and another 60 to 80 in Latin America on top of that. It's not because it's riskier, but potentially it's a liquidity issue. There is an illiquidity premium in it.
But it's really about supply-and-demand balance. This is what people are prepared to pay to lock in for the long term. The question is, is this stuff illiquid? It's not like a Treasury where you can just get rid of it. But it's much like any other fixed income investment. If there's something wrong with the investment and you try to get rid of it, it's going to be tough. But if there's nothing wrong with the investment and you just need some liquidity, you'll be able to sell it in a short time frame. It's pretty transferable.
When we're discussing infrastructure, are we talking transportation projects? Energy?
We really want core infrastructure. Regulated assets such as electric utilities and airports. Contracted power—energy generation—is another. Renewables. Energy-related infrastructure such as transmission lines. Midstream infrastructure, which is moving and storing energy. Gas pipelines. Gas storage. Transportation, such as roads, is another, although they're mostly funded with municipal bonds so not in scope. And occasionally, public-private partnerships.
Put on your devil's advocate hat. What are the downsides for an insurer investing in infrastructure debt?
Illiquidity is the issue that people tend to think. The other thing is locking into long fixed rates in a time when the Treasuries are low. But my view is you have to think at a global level. How much long-term fixed rate do I want? For the proportion you decide you want to be in fixed income, this is as good as it gets.
Given the long-term nature of infrastructure, can P/C companies invest?
People tend to think, “This is super long duration. It's ideally suited to a life company.” We have a variety of different investments in our book. I think the average duration of investments in our book is around 14 years. That's reasonably long. But actually quite a bit of it is 8- to 10-year duration, especially with the renewables, and there's a lot of those. Some of the shorter durations could be investments for a P/C company.