Get real: Opportunities in infrastructure and real assets private debt

October 25, 2024

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Like other parts of the world, Asia urgently needs capital to upgrade its infrastructure. Andrew Tan makes the case for investment in the underserved middle market.

In 2018, the Global Infrastructure Hub, an initiative launched by the G20, published what was and remains the most comprehensive analysis to date of the planet’s long-term annual infrastructure financing requirements. 

It estimated that between 2016 and 2040, US$97.2 trillion would be needed globally to “keep pace with profound economic and demographic changes, and to close infrastructure gaps”.¹ It added over half of that capital – US$50.7 trillion – was needed by Asia Pacific countries, while highlighting that the current pace of investment would lead to a US$19.4 trillion shortfall by 2040 (Figure 1).

Subsequent analysis by other bodies suggests insufficient progress is being made to fill the gap. According to the Asian Development Bank (ADB), approximately US$13.8 trillion of investment is needed in infrastructure and other real assets between 2023 and 2030 to ensure Asia’s economic growth targets are met.²

Historically, around 90% of infrastructure in the region has been funded by the public sector.³ But, as the ADB and other multilateral agencies including the International Monetary Fund have repeatedly highlighted, increasingly “governments, central banks, financial supervisors, and multilateral institutions must coordinate and develop a comprehensive strategy to attract more private capital”.⁴

In an effort to play our part in supporting Asia’s financing requirement, in September 2024 Muzinich & Co. announced the launch of a new Infrastructure and Real Assets Private Debt Strategy in partnership with Hong Kong-based Orion3, an asset manager backed by CK Asset Holdings Ltd (CKA).

In this Q&A, Andrew Tan, Asia Pacific CEO and Head of Private Debt at Muzinich & Co., discusses the opportunity in real assets private debt, particularly in what he views as the underserved middle market.

Why is now the right time to expand our private debt capabilities into real assets?

There are two main drivers. Firstly, Asia Pacific investors have historically liked investments backed by physical assets, particularly real estate.⁵ But, given the challenges in certain parts of the commercial real estate market in the last couple of years, we felt there was a gap for a strategy that could offer investors the downside protection of hard collateral, diversification and potentially attractive returns. 

In our view, infrastructure and real assets can meet that diversification need, providing investors with access to a broad range of sectors such as power and renewable energy, utilities, telecommunications and digital infrastructure, logistics-related infrastructure and energy transition. There are also opportunities in the built environment, in sectors such as student accommodation, care homes and hotels. What ties these together is that they are all hard assets with tangible value.

The second part of the story is that in the course of building up our Asia Pacific private debt platform, we were increasingly seeing deals that had an element of development risk, including a requirement for “last-mile” financing to get projects or companies to the point where they would be cashflow generative.

Here, we are not talking about large-scale infrastructure projects where governments or big companies are involved. Those deals are high profile and there is a lot of capital chasing them from already established infrastructure players and private equity firms.

In our view, more compelling opportunities can be found in the next tier down – in the US$25 million to US$75 million range, where borrowers may find it difficult to access financing from traditional sources. These sorts of transactions were ineligible for our first APAC private debt vehicle, which was not designed to take on development risk.

After identifying the opportunity, we also recognised the need for the right technical and operational expertise of real assets. The question then became how we might partner with a credible institution with the prerequisite capability on the asset side. That is how our tie-up with Orion3/CKA emerged.

“We felt there was a gap for a strategy that could offer investors the downside protection of hard collateral, diversification and potentially attractive returns.” Andrew Tan

Which geographies are you focusing on?

From an origination standpoint, we have a bias towards developed markets, particularly in Asia, where we are looking at opportunities in Australia, Japan, Korea, Singapore and Hong Kong. Opportunistically, we will look at transactions in Southeast Asia if they make sense from an economic and risk perspective, and we can also look at markets like the UK and Canada, which have established real assets and infrastructure sectors.

If you take Australia, it has deep and established infrastructure and property markets, as well as an emerging private corporate credit market. What you are not seeing is middle-market infrastructure strategies, which we feel is a gap that we can naturally fill.

What types of clients could a real assets private debt strategy appeal to?

We believe real assets have a wide appeal. From an institutional client standpoint, investors who have typically allocated through private equity might find the opportunity to get exposure higher up the capital structure with downside protection as attractive. We also believe we can provide diversification by virtue of the size of companies and types of assets we are targeting. 

We are also seeing a positive response from high-net-worth investors and family offices. I believe that is down to two factors. Firstly, we have partnered with a premier name in the real assets market with whom many people may wish to be associated. The second aspect, which I mentioned earlier, is that Asian investors gravitate towards investments backed by hard assets with downside protection. We can meet that demand and provide diversification away from purely real estate-focused strategies.

To what extent are opportunities linked to sustainability requirements?

In some of our focus sectors, several transactions will fall into the category of sustainability and the transition towards net zero. The strategy is also classified Article 8. Although we firmly promote sustainability, the strategy is, first and foremost, focused on risk and return and making sure the economics work.

What does the risk-return profile look like relative to more traditional private debt strategies?

We believe we are approaching this differently to traditional players, where the tendency is to focus on larger, fully developed assets. Whilst that is one way to approach the market, I would question whether that is addressing the need or the funding gap. What you find with many small and medium-sized opportunities is that they are not quite complete or at full capacity. Given the uncertainty around interest rates, it can be difficult to value the equity in a lot of situations. So, if a company is trying to raise equity to get to full capacity or completion, that comes with the risk of a dilution of capital. Anecdotally, we often hear this raised as a concern.

Our focus is to bridge the gap, providing senior-secured financing for last-mile situations. We also see opportunities where companies have assets that are already generating cashflows, but they are looking to increase capacity through capital expenditure or an acquisition. In such situations, we can come in as a mezzanine lender or provide unitranche debt.

“We are not pitching this as a sustainability strategy – first and foremost, this is about risk and return and making sure the economics work.” Andrew Tan

We believe potential returns are higher than those available in traditional infrastructure. This is because the deals are smaller and in a less-crowded space. The tenors of the deals we are looking at are also shorter – anywhere from 2 to 5 years, rather than the 7, 10 or 15 year-plus maturities you might see in traditional strategies.

In terms of risk mitigation, one of the crucial aspects is the operational and development expertise of Orion3/CKA, who are involved in this asset class day in, day out. They have skin in the game on the strategy, so there is an alignment of interests. We are both involved in the due diligence and investment selection process; we combine our strengths in credit analysis with Orion3/CKA’s asset class and operational knowledge, including what to do in a disposal scenario.

Secondly, there is security held against these assets, whether the loan is senior-secured or mezzanine, as well as covenants written into the documentation.

Are you looking for opportunities on a standalone basis or in partnership with public institutions?

On a selective basis, there may be opportunities to partner with public institutions, including development banks. However, they tend to focus on providing funding to projects in developing countries. Given our experience in private credit in jurisdictions like Vietnam, Indonesia, Philippines, India and Thailand, we might consider partnering with a public institution on opportunities in those markets if the economics work.

References

1.Global Infrastructure Hub, ‘Infrastructure investment needs to 2040,’ June 2018. Most recent available data used.
2.Asian Development Bank, Reinvigorating Financing Approaches For Sustainable and Resilient Infrastructure In ASEAN+3, May 2023.
3.Asian Infrastructure Investment Bank, ‘Asian Infrastructure Finance Outlook 2023,’ January 2023.I
4.IMF, ‘Explainer: How Asia Can Unlock $800 Billion of Climate Financing,’ January 29, 2024
5.Savills, ‘Asian investors are driving cross-border real estate deals,’ March 14, 2024.

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of October 2024 and may change without notice.

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