An ambitious plan by the European Commission to turn the European Union into a €315 billion ($357 billion) building site from the middle of this year to boost economic growth has been eclipsed, at least in the headlines, by the European Central Bank’s decision to pump money into the economy with the same end in mind.
Yet the EU’s big infrastructure-spending plan should complement the ECB’s quantitative easing by increasing both the demand and the supply side of the economy. And Europe’s insurers are licking their lips in anticipation of mammoth investment opportunities.
In November the Commission, the EU’s executive arm, unveiled plans to promote a major infrastructure investment program. EU institutions will provide €21 billion in investment guarantees in a bid to attract much greater involvement by the private sector and reach the total goal of €315 billion.
“Europe urgently needs to modernize its infrastructure,” says Andreas Gruber, Munich-based chief investment officer of Allianz Investment Management, the €600 billion asset management arm of German insurer Allianz. “Companies like us are able to finance this, as we are looking for long-term investments to fund the old-age pensions of our clients.”
Gruber declines to predict the size of future investments but says, “We think this is a very attractive area, especially because of our long-term liabilities, and we’re looking forward to further investment opportunities there.” Allianz’s latest figures, for June 2014, show the firm had invested €1.8 billion in infrastructure debt, up 174 percent from a year earlier, and €1.6 billion in infrastructure equity, up 16 percent on the year.
Munich Re, the giant reinsurer, is aiming to increase its infrastructure investment to €8 billion, or about 3.3 percent of its investment portfolio, with half in debt and half in equity. The firm has committed some €1.5 billion so far.
With EU governments struggling to restore growth and institutions looking for higher-yielding investments, infrastructure “is one way out of some of our problems,” Munich Re CEO Nikolaus von Bomhard said in an interview at the World Economic Forum in Davos. He said Europe’s big insurers have plenty of appetite for investing in the sector: “If you add it up, it’s certainly in triple digits.”
The current low-yield environment, reinforced by the ECB’s latest policy move, is fueling much of the interest in infrastructure.
“Once insurers’ yields go significantly below 4 percent, it becomes increasingly difficult to meet their liabilities,” says Patrick Liedtke, head of the financial institutions group for EMEA at $4.7 trillion-in-assets BlackRock in London. Infrastructure debt — or a mix of infrastructure debt and private equity — can improve returns on insurers’ portfolios while decreasing the correlation with other asset classes, he says.
Infrastructure debt has another attraction, Liedtke says: It often pays a steady income stream over as long as 30 years, creating a steady cash flow that allows insurers to meet long-term liabilities. Liedtke calculates that even relatively safe infrastructure debt can offer yields of 2 to 2.5 percentage points above sovereign bonds, with more available if insurers are willing to take more risk.
A survey of 201 institutional investors, including insurers, published by BlackRock in December found that 66 percent owned infrastructure assets, with 72 percent planning additional equity investments and 38 percent planning new debt investments.
Gruber of Allianz IM contends that there are some “supersafe types of investment” in European infrastructure. He cites payments made by a government for new roads, for which the payment depends only on the building and maintenance and not on the volume of traffic.
One such example is the €1.24 billion, 25-year bond issued in 2013 by the Granvia consortium, a public-private partnership that includes Allianz, to refinance an expressway in Slovakia. The bond is backed by payments by the Slovakian government for maintaining the quality of the road.
Road projects whose payments are tied to traffic volume offer higher yields — and greater risk. “Depending on the risk, the current yields can range from the low- to mid-single digits, to more than 10 percent for risky assets,” says Gruber.
One impediment to greater infrastructure debt investment is the EU’s Solvency II capital regime. That directive, which will come into force in January 2016, requires insurers to hold more capital to guard against risks in their portfolios.
Munich Re is lobbying EU regulators to have infrastructure debt treated like real estate, rather than corporate bonds, for capital purposes; such a change would cut the capital requirement in half, von Bomhard estimates. In response to calls from the European Parliament for easier capital requirements, the European Commission’s head of financial services, Lord Jonathan Hill, wrote last month that the commission was considering a “more risk-sensitive treatment” of infrastructure debt.
Solvency II also has an impact on insurers’ demand for private equity investments in infrastructure, says Liedtke of BlackRock. The directive will impose a 49 percent capital charge for private equity investments if they form the entire portfolio of an insurer, but the charge starts at only 25 percent and stays low if private equity is part of a balanced portfolio, notes Liedtke. “We very often find that insurers are not making full use of the diversification benefits of Solvency II,” he says.
Capital charges reflect the fact that infrastructure is not a riskless investment. For example, Allianz’s $1 billion investment in Gassled, a Norwegian gas infrastructure project, was hit in 2013 when the Norwegian government decided to cut tariffs for gas transportation by as much as 90 percent.
In the light of these risks, insurers and their asset managers lean toward safe projects while being prepared to invest in riskier ones if the price is right. When investing in infrastructure for insurers, “we tend to be on the conservative side, because we want to make sure that what we do is very dependable from a risk perspective,” says Liedtke. This sentiment is echoed by Gruber of Allianz IM: “You have to analyze each single asset in detail. There might be low-risk assets where the return is too low and high-risk assets where the return is attractive.”
A lack of expertise in analyzing issues such as construction risk is hampering investment in greenfield projects, says Giles Frost, CEO of Amber Infrastructure, the fund manager for International Public Partnerships, a London Stock Exchange–listed infrastructure fund. Many insurers “are ill-equipped to buy the less mature assets — the sort of assets, still apples in the eye of their begetters, which are being promoted by the EU,” he says. As a result, “insurers are currently struggling with how to increase their access to the supply of infrastructure.”
International Editor Tom Buerkle in New York (on Twitter at @tombuerkle). contributed to this article.
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