3 minute read
As investors await the bottom of the interest rate cycle, we consider three key themes to look out for in private asset markets.
1. Healthy deal flow to continue
As the prolonged era of extraordinary monetary policy winds down, we expect healthy deal flow to continue across the spectrum of private assets. With the market calling the bottom in the latest interest rate cycle, sponsors of private assets may look to refinance transactions before the next upward shift from major central banks. Borrowing costs will not remain at such attractive levels indefinitely.
As such, we believe the market for private asset financing is likely to remain active in 2018, characterised by a small number of greenfield projects, a peak in refinancing opportunities and healthy merger and acquisition-related deal flow.
While growth in Europe is accelerating, so are opportunities in private corporate debt. After a post- crisis record year in 2017 with around €80 billion of institutional loan issuance, January 2018 saw a healthy €14.3 billion of transactions1, which is further increased by opportunities in the small cap sector.
Although new construction activity in Europe is expected to be relatively subdued, there are green shoots in some parts of the market. In UK real estate these include the growth of the private-rented sector. Here, demand for new housing units far exceeds supply, with around 130,000 units coming to market each year against demand of around 200,000 to 240,000 homes2. Institutional investors currently hold less than two per cent of the market, but there has been a wave of interest from income seekers, including those wanting to take advantage of the relative weakness of sterling.
In energy, a lack of greenfield wind and solar projects will mean a focus on a small number of new waste/biomass schemes and the continued growth of offshore wind. The sector is developing rapidly, helped by subsidies to promote less established technologies as part of the government’s Industrial Strategy. Plans coming on-stream include the first institutional investor-led offshore wind farm - once operational, the Hornsea project in East Yorkshire will be the largest in the world. Refinancing opportunities may also appear as other large wind farms become operational.
Investment in rolling stock is expected to continue in the UK and France, part of the ongoing modernisation of rail infrastructure. There is also expected to be a concentration of activity around Spain’s new €5 billion public-private investment programme, which is targeting the construction of around 2,000km of roads.
Meanwhile, a significant amount of institutional capital is ready to be put to work. “With the volume of private infrastructure equity seeking a home, shareholders are seeking value by trading stakes at the end of life for some closed-end funds,” says Darryl Murphy, Aviva Investors’ head of infrastructure debt. “The market will continue to see asset sales that will bring new debt opportunities for investors, many of whom are longer-term investors actively seeking longer-term, stable capital structures.”
2. Demand driving down returns
Demand among institutional investors for private assets continues to be strong. Solvency II has led insurers to search for assets eligible for favourable capital treatment, and several countries including Italy and Spain are facilitating non-banks’ investing in loans. Pension schemes are looking more closely at risk budgeting and enhancing risk-adjusted returns as well.
“Institutional investors are expected to continue to increase their investment in private assets in 2018,” says Laurence Monnier, head of alternative income strategy and research at Aviva Investors. “This is likely to put pressure on returns from trophy transactions, while better value will be found in less visible or more complex deals.”
In commercial real estate finance, for example, pricing for loans backed by trophy properties has fallen to under 100 basis points over mid-swaps for A or BBB-type risk in Germany3; pricing differentials between different European markets have fallen too. At the higher end of the risk spectrum, leveraged loans have also been in high demand, pushing down borrowing costs for indebted companies, while there has been a gradual erosion of protections in covenant-light loans.
We see opportunities in less crowded areas of the market, such as lending to European small/mid caps (companies with EBITDA >€10m), with B or B+ type ratings. “The small and mid-cap segments are growing and resilient, with better risk-adjusted returns compared to the covenant-light structures applied to the large cap sector,” says Antoine Maspétiol, head of private corporate debt at Aviva Investors. Yields of around four per cent can be achieved for B-rated credits.4
Many companies in these sectors are seeking to diversify funding sources outside banks, hoping for a long-term strategic partner. This is a role pension schemes and insurance companies may be well suited to; non-bank lending already accounts for around 40 per cent of the market4. Borrowers tend to be more conservative in their requirements than large caps, yet the universe is still diverse enough for managers to be selective. The annual flow of debt is estimated at around €54 billion in France alone, spread across a variety of sectors.
Institutional investors are expected to continue to increase their investment in private assets… This is likely to put pressure on returns from trophy transactions.
3. Illiquidity premia persists with a premium on innovation
In spite of competitive market conditions for high profile transactions, illiquidity premia persist (see illustration below).
Trends in illiquidity premia (2006-2017)
For illustrative purposes only. Note: Axes truncated above 300 bps and below 0 bps. Source: Aviva Investors, as at 29 December 2017.
Innovation, both in terms of sectors and structures, is likely to command a premium, but it is important to keep a close eye on risk. “Similar to the re-emergence of covenant-light debt, we are increasingly seeing infrastructure equity investors making optimistic assumptions and disregarding risk in their search for higher yields,” says Ian Berry, head of infrastructure equity at Aviva Investors. “More innovative approaches, such as unlevered investment, can provide better downside protection and contribute to more stable income.”
Identifying and understanding the idiosyncratic risks associated with private markets investments will be particularly important as interest rates begin to climb.
- Bloomberg, Leveraged Finance Chartbook, January 2018. Excludes repricings..
- Knight Frank..Specialist Property Sector Report 2017: Private Rented Sector
- Aviva Investors. As at 29 December 2017
- Aviva Investors. As at 29 December 2017
- Deloitte UK Alternative Lender Deal Tracker, Q3 2017
Similar to the re-emergence of covenant-light debt, we are increasingly seeing infrastructure equity investors making optimistic assumptions and disregarding risk in their search for higher yields,
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (Aviva Investors) as at 19 February 2017. Unless stated otherwise any view sand opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this document, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. This document is not a recommendation to sell or purchase any investment.
In the UK & Europe this document has been prepared and issued by Aviva Investors Global Services Limited, registered in England No.1151805. Registered Office: St. Helen’s, 1 Undershaft, London, EC3P 3DQ. Authorised and regulated in the UK by the Financial Conduct Authority. Contact us at Aviva Investors Global Services Limited, St. Helen’s, 1 Undershaft, London, EC3P 3DQ. Telephone calls to Aviva Investors may be recorded for training or monitoring purposes. In Singapore, this document is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited for distribution to institutional investors only. Please note that Aviva Investors Asia Pte. Limited does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Asia Pte. Limited in respect of any matters arising from, or in connection with, this document. Aviva Investors Asia Pte. Limited, a company incorporated under the laws of Singapore with registration number200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1Raffles Quay, #27-13 South Tower, Singapore 048583.In Australia, this document is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd for distribution to wholesale investors only. Please note that Aviva Investors Pacific Pty Ltd does not provide any independent research or analysis in the substance or preparation of this document. Recipients of this document are to contact Aviva Investors Pacific Pty Ltd in respect of any matters arising from, or in connection with, this document. Aviva Investors Pacific Pty Ltd, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000
The name “Aviva Investors” as used in this presentation refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom. Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager. Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) and commodity pool operator (“CPO”) registered with the Commodity Futures Trading Commission (“CFTC”), and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606