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Memos from Howard Marks: Ruminating on Asset AllocationMarket / Infrastructure
Infrastructure: Leveraging the Benefits of Private Infrastructure Debt
09.17.2024
Infrastructure investing offers a range of potential benefits for investors, including diversification, income and risk mitigation. Although infrastructure consists of a wide range of the assets that underpin the global economy, from roads and bridges to data centers and renewable energy projects, they all share a set of common characteristics that contribute to the appeal of the asset class. For example, they offer essential services, have high barriers to entry, enjoy long operational lives, have contracted or regulated revenues tied to inflation, and typically have high operating margins.
Investors can access these opportunities through both public and private equity markets – as well as through debt investments.
Private infrastructure debt emerged as a significant asset class alongside the rest of private credit following the 2008 Global Financial Crisis (GFC). Prior to that, the dominant financing sources for infrastructure lending had been banks, led mostly by international banks and their project finance groups. However, changes in the regulatory landscape after the GFC curtailed their appetite for this type of long-duration lending. These changes, coupled with the required investment across infrastructure, have opened up a significant need for private capital as a lender to owners and operators of these assets.
We believe an allocation to private infrastructure debt can be a compelling allocation within portfolios for three reasons:
- Potential diversification benefits and incremental returns. Because of the characteristics of the underlying assets mentioned above, infrastructure debt has the potential to offer diversification benefits to investment portfolios and attractive risk-adjusted returns.
- Lower default rates. Infrastructure debt generally has a lower incidence of default and higher recovery rates compared to non-financial corporate debt, according to a Moody’s analysis (see chart below). The cumulative five-year default rate for non-financial corporate debt has been 9.6%, while infrastructure corporates and project finance has been 2.4%. The inelastic demand for infrastructure services helps support the cash flows to service interest payments, while the essential nature of the underlying assets helps support the higher recovery rates if these assets do become distressed.
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Source: Moody’s Infrastructure Default and Recovery Rates, 1983–2022.
- Access to today’s market opportunity: We believe the world is in the midst of an infrastructure “super-cycle” marked by major efforts to modernize existing infrastructure, as well as invest in projects required as new technologies emerge. As a result, the need for private capital, for both debt and equity funding is only growing. According to Bloomberg, there is a need for $200 trillion in investment over the next 30 years, primarily across what we have termed the “Three Ds”—digitalization, decarbonization and deglobalization.
The bottom line: When underwriting these investments, it’s important for investors to consider the barriers to entry, growth plans, credit quality, and refinancing risks. We believe investors therefore can benefit from partnering with managers who have the requisite deep credit expertise, are able to deploy significant capital, which can reduce competition, and have a local presence in the markets they are investing in, which can facilitate direct deal sourcing. In our view, investors who do so will be best positioned to take advantage of the sector’s attractive risk-adjusted returns and diversification benefits, while potentially earning a premium over loans made to similarly rated corporate debt.
Read the Alts Quarterly, where we discuss the infrastructure outlook and themes affecting other key alternative asset classes.
Full disclosures in linked PDF.