Source: EDHECinfra (2022a) as of June 2022
Note: Unlisted infrastructure debt performance is measured by EDHECinfra's InfraDebt300 index. Gross returns is a measure of overall market performance of the index, captured through capital appreciation in market value plus net income accrual relative to the initial value of the asset.
Between 2011 and 2020, average total returns on private infrastructure debt increased strongly (6%). This trend temporarily stalled during the pandemic in 2020 and 2021. But in 2022, global interest rate hikes prompted investors to move towards other less risky fixed-income assets. This shift created a decline in demand for and total return on private infrastructure debt, breaking the record of nearly a decade of consistently positive returns.
In 2022, total return on global infrastructure debt declined by 12%. While income returns on infrastructure debt remained stable at around 3.5%, the decline in total returns was driven by a decrease in the capital return on infrastructure debt (–16% in 2022), according to the EDHECInfra Infra300 Debt Index. This decrease occurred because the rise of interest rates generated a decline of the market price of existing infrastructure debt, which mostly has interest payments fixed at the preceding lower interest rates. Rising rates also affected infrastructure debt risk but to a lesser extent. By the end of 2022, volatility in returns increased from 4.5% over the past 10 years to 5.6% over the past three years.
The decline in return on global corporate debt has been more dramatic. Non-financial corporates are facing a triple threat of declining demand, persistently higher costs, and investors’ increased risk aversion. While infrastructure is backed by stable and resilient cashflows that support its debt repayment capacity, corporate borrowers find it more difficult to pass through high input costs to consumers, which combined with weakening demand due to a looming recession are reducing corporate profits. Credit risk on corporate debt is high and worsening with sharply higher interest rates pressuring borrowers’ debt service capacity against the backdrop of high debt levels, according to the Standard & Poor’s (S&P) Global Credit Outlook 2023. Return on non-US investment grade bonds index declined by 22% in 2022, and annualised risk increased from 9.8% over the past 10 years to 14.0% over the past three years. Return on US investment grade bonds declined by in total returns by -12% and risk increased from 3.8% over the past 10 years to 5.5% over the past three years.
Meanwhile, infrastructure debt has shown more stable return and risk than other asset classes, despite the negative effects of rising interest rates. It remains attractive for private investors on account of its relatively stronger inflation-hedging potential than that of other investment options, as a result more capital than ever is being allocated to infrastructure to mitigate inflation risk. Private infrastructure capital raised per annum quadrupled from about USD31.5 billion in 2010 to USD174 billion in 2022, according to Preqin.
In an inflationary environment and as investors’ risk aversion rises amid high uncertainty on the future economic outlook, the resilient performance and lower credit risk of infrastructure debt is increasing the attractiveness of infrastructure debt among private investors.