(October 17, 2013) – Investors interested in infrastructure debt should invest through the entire capital structure, according to UBS.
Tommaso Albanese, head of infrastructure debt at UBS, told delegates at the National Association of Pension Funds conference in Manchester, UK, that investors should not be tempted to pick and choose among the various types of capital structure, and instead adopt a vertical approach.
Taking this approach helps investors get the best opportunities from greenfield, brownfield, and secondary markets, he said.
“Our solution is to invest across the entire debt capital structure,” he said. “Investors must be prepared to be flexible and invest across a variety of debt products.”
Using a vertical approach would lead to returns of between 5% and 6% on an investment-grade portfolio, Albanese continued.
The active management involved in investing in this way would also produce a yield of 200 basis points (bps) more than a passive debt portfolio strategy, he said.
UBS currently manages $1 billion in infrastructure debt, with the average investment amount totalling around $100 million.
Albanese also dismissed any concerns about capacity constraints in the infrastructure market, saying: “There’s a lot of talk about infrastructure debt but not a lot of activity going on at the moment.”
Opting for a total investment policy was also declared the right decision for real estate debt, by Albanese’s colleague and Head of Real Estate Debt at UBS Anthony Shayle.
Rather than investing in mezzanine level real estate debt, which boasts attractive returns but poses creditor problems at the point of insolvency, Shayle favoured what he termed a “whole loan” approach.
“Mezzanine debt is always weak when it comes to terms of control,” Shayle told delegates. “They’ll get second charge at best. The chances of a mezzanine lender getting their money out in a distressed enforcement situation are not great.”
The whole loan approach uses only senior loans, which have seen returns rise from 170 bps to 331bps in the past five years.
Whole loans have a loan-to-value range of up to 75%, meaning there’s a 25% equity cushion, and target a gross return of at least 8%, Shayle said.
That total was reached by adding the basic real estate coupon to the rental profit share and capital appreciation of the asset.
This method of blending the categories of return provides a level of inflation protection and a share of any capital gain, without the risks associated with mezzanine or subordinated debt, he said.
Deal sizes with whole loans tend to be small however: the typical investment is around £10 million to £40 million, and mostly through pooled vehicles.
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