By Josh Pandolfi, Managing Director and Senior Portfolio Manager at Pontoro, a financial technology company
Higher interest rates, tightening monetary policy, persistent inflation, global macro uncertainty, and more stringent bank conditions have roiled the global capital markets and made investing more challenging. While these conditions have tested even the most sophisticated investors, one asset class continues to prove its resilience: core infrastructure. These are the assets that we rely on to move the world forward, while providing essential services and fulfilling basic human needs, such as water, transportation, electricity, and healthcare. As other asset classes continue to face headwinds, infrastructure assets continue to perform and provide strong risk-adjusted returns – but only if investors can access them.
Investors have typically gained exposure to these assets through equity or subordinated debt, and only the largest investors have had a broad ability to invest at a senior level. There remains a large source of untapped institutional capital that is seeking ways to invest in senior-secured infrastructure, an attractive risk profile in times of market volatility. New paradigms in the market alongside new technologies are creating the right conditions to give a broader spectrum of investors access to the safest rank of this in-demand asset class.
Decarbonization, sustainability, energy security, affordability, and industrial competitiveness are of utmost importance these days, but there is simply not currently enough capital to improve existing infrastructure, let alone build new assets to meet these needs. Governments are trying to step-in through various incentives, but it’s not enough – and many governments are facing their own fiscal challenges. New solutions need to arise to unlock additional capital and help bridge what is expected to be an almost $1 trillion annual shortfall in funding for infrastructure.
Private, senior-secured infrastructure lending has traditionally been a space dominated by the commercial banks because they can offer the most competitive terms, support the depth of expertise necessary to analyze the assets, maintain the balance sheets at the scale necessary to invest large amounts of capital, and have the ability to hold assets for longer durations. While banks find the asset class very attractive and are intent on continuing to support borrowers in the industry, they are coming under increasing pressure themselves. Heightened reserve requirements under Basel III and IV are restricting bank capital, reducing a bank’s ability to support new deals. Consolidation between banks is creating larger positions in these loans across fewer institutions, leading to concentration issues. Finally, there are less syndication partners, as regional banks and other lenders curtail lending, leading to an inability for the banks to sell down these loans and recognize fees. Consequently, banks are now looking for new sources of capital to help manage their exposures in order to recycle capital into new deals and maintain their leadership role within the industry.
This is where technology can help bridge the divide. As banks look to sell down their portfolios, there is the technological potential to analyze such loans and build a diversified portfolio of infrastructure loans. Digitalization could help connect institutional investors, of all sizes and commitment levels, to this highly credit-worthy portfolio of loans, removing the typically high barriers to entry. Investors could then customize their portfolios through tech-enabled additional fractionalization. Such solutions would aid capital flows to make the process more efficient, accessible, and transparent, while also reducing costs, thereby passing along a majority of the income earned from the loans.
By increasing access to senior-secured infrastructure loans through advancements in digital finance platforms, more investors would receive the benefits they are seeking during market volatility, including long durations, floating rate exposure to help offset any current interest rate risk in their portfolios, and seniority of cash flows in the waterfall and the additional structural protections afforded to lenders at the top of the capital stack. In addition, these investors would also gain the positive attributes of core infrastructure assets, including steady and stable cash yields, inflation resistance, and downside protection.
The case for investing in senior infrastructure debt by institutional investors is clear and market conditions have coalesced to provide the optimal entry point. This timing coincides with new technologies that make financing faster, safer, and more inclusive. A broad spectrum of institutional capital can now step in to help alleviate the capital issues facing the banks, while financing the infrastructure needs required to accelerate economic growth.
Author: Josh Pandolfi
