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PRIVATE PLACEMENTS AND
INFRASTRUCTURE FINANCE
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Private placements and project
infrastructure finance can effectively
increase portfolio diversification, say
Calum Macphail and Martin Lennon
Historically, private debt assets have been considered the preserve of
in-house specialist debt investors. The very private nature of the assets
has ensured their reputation remains obscure. However, there are
excellent opportunities for pension funds in these asset classes which
are uncovered by delving further into the fixed income markets.
It is likely that the majority of readers will have never considered assets
such as private placements and project and infrastructure finance in any
form. These assets are commonly accused of being illiquid, expensive
to access and unrated, therefore unsafe.
It does not have to be like that. Such assets can be held to effectively
increase portfolio diversification, provide additional yield and improve
the risk/return trade-off of the overall scheme portfolio. Private
placements offer the investor better protection than a mainstream fixed
income asset and they are often household names, generally equivalent
to investment-grade quality. Many investors are unlikely to be aware that
project and infrastructure finance transactions are often indexlinked and
so offer inflation protection and good, long-term matching prospects for
long-term scheme liabilities.
Essentially, private placements are unlisted and unsecured debt and
although not typically publicly rated, they are predominantly of
investment-grade quality. Private placements attract more stringent
documentary terms than the typical bond issue, including financial
covenants, which minimise the risk of capital erosion of the investment.
Though private placements tend to be unsecured, holders rank
equivalent to a company’s banks, generally at the most senior level in a
company’s capital structure.
Private placements
Private placements are debt typically raised by European mid-cap
companies as an alternative to bank loans or public bond issuance and
as part of a diversified funding strategy. They are usually fixed-rate and
longer-dated than bank loans (10 to 15 years on average).
Examples of companies who have issued in the private placement
market in recent years range from large multinationals, such as cement
producer Cemex and car company BMW, to UK companies such as
Johnson Matthey and several of the UK’s largest house builders.
Private placements are suitable for inclusion in mainstream fixed income
portfolios to improve diversification, return stability and excess returns
over the medium to long-term. Not only do private placements offer the
possibility of generating additional yield, but they also provide the
opportunity to increase portfolio diversification by industry and credit
quality. This, combined with the ability to lower credit volatility through
the inclusion of covenants in the documentation, make private
placements a valuable opportunity for pension funds.
Individual project and infrastructure finance transactions are discrete
and, consequently, there is a low correlation with wider market
movements – just what pension funds are looking for. Many transactions
are index-linked which affords inflation protection to the investor in
addition to a credit spread, again, often a pension fund preference. Risk
potential is lowered through subcontractual arrangements to experienced
Calum Macphail is head of
corporateprivate placements at
Prudential M&G
Martin Lennon is head of
project and infrastructure
finance at Prudential M&G
specialist companies and there is a higher potential for significant
recovery on default since there is often security over the asset or right to
operate the asset. In a recent securitisation of such assets, Standard &
Poor’s reported an average recovery rate expectation of 85% across the
portfolio in question.
Infrastructure finance
Project and infrastructure finance describes senior debt, junior debt and
equity investments in building and infrastructure projects such as
hospitals, schools, roads, prisons and transport. A significant portion of
investment falls within the UK government’s private finance initiative.
Investments are secured on cash flows arising from a particular project
and are usually very long-dated (eg 15+ years).
Project and infrastructure finance can provide two roles for pension fund
investors. First, the senior debt investment may be held to provide
diversification, performance enhancement and stability. Such senior
debt issuance may be in public bond or private loan form. Public bonds
are usually rated by the external rating agencies and often wrapped by
a monoline insurer to achieve AAA/Aaa status. Private senior debt is
usually unwrapped with a credit profile equivalent to the BBB range.
Alternatively, junior debt and equity investment can form a useful role in
a pension fund’s allocation to alternative assets. Project and
infrastructure equity has property-like characteristics, in that it is very
long-dated with stable, predictable indexlinked payment streams.
These types of investments offer a number of benefits to pension funds.
The attractions of credit quality, stable cash flows, long maturities and
the potential to structure inflation-linked financial assets supported by
essential public infrastructure, make investments in this asset class
worthy of serious consideration by pension fund trustees.
One hurdle in investing in both private placements and project and
infrastructure finance is gaining access to the assets.
For example, project and infrastructure finance transactions usually
require significant funding, suggesting pooling. Private placements are
difficult to access directly without established links with the investment
banks that are usually agent to transactions. Both asset classes have
low liquidity and less price transparency than mainstream fixed income
assets.
Prudential M&G’s significant investments underlines that the benefits
significantly outweigh the wrinkles. In a market of low bond yields, this
kind of portfolio diversification can add noticeable sparkle.
www.prumandg.com
This document is provided for information purposes only. Any change to your investment circumstances should be discussed with your investment advisor.
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