CASE STUDY

Infrastructure debt

UK Corporate Pension Plan | Autumn 2018

Engagement at a glance

A UK corporate pension plan was seeking to invest £200 million in infrastructure debt in the UK/Europe, using one or multiple managers. Both pooled funds and SMAs were considered, with an absolute return target of LIBOR/EURIBOR+150-200bps net of fees.

Although this investor was looking for predominantly senior debt exposure, early exploration concluded that some subordinated debt would be appropriate for their risk tolerance and return objectives, up to a maximum of 25%.

Client-specific Concerns

While investors in senior infrastructure debt tend to prefer their home currency, this client was open to European as well as UK loans, particularly in light of Brexit concerns. One option under consideration was investing through an asset manager owned by the same parent institution, but the investor was keen to ensure proper governance of any such decision.

Outcome

  • A clear understanding of the provider landscape. Managers fall into four categories: insurers raising pooled funds to invest alongside their own infra debt investments; large diversified asset managers; infrastructure managers (e.g. specialists on the equity side who are branching out into debt), and a small contingent of infra debt specialists.

  • Scrutiny of risk management and track record. Given the advanced stage of the investment cycle, probing managers’ capability and experience in stressed scenarios is key. In addition, track records are limited and harder to assess fairly; a lot of teams have moved around in recent years. The team explored: what deals did the team say no to, and why? Is the manager a “price maker” or a “price taker” (many managers work together on transactions)? It’s important to look past simplistic charts showing returns against a government bond curve and examine yield-to-maturities and how these moved against expectations.

  • Taking care on costs and alignment. There was a broad range of fee offerings, as well as interesting differences between managers in terms of their willingness to share all, part or none of the origination fees that they received from borrowers. Beware of managers charging investors additional fees for origination. Watch out for alignment: the relatively low returns mean that the senior portfolio managers rarely invest in the strategies. Some managers believe that having an insurance parent (“the house”) invest alongside the fund is an adequate demonstration of alignment; we are sceptical on this point. As a result, a lot of attention was paid to the compensation structure of the investment team.

 

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