Infrastructure Debt: From Opaque to Opportunity

Greg Campion: Infrastructure debt continues to gain acceptance as a core allocation among institutional investors, given the strong structural tailwind, supporting the build out of infrastructure assets in North America and around the world. But lots of questions remain like how do you actually define infrastructure? What role are asset managers playing today in the space and how has that changed? What does the return profile look like for the asset class? And finally, who is investing in infrastructure today and why?

Orhan Sarayli: This is something that is going to continue to happen. This space is growing, it's evolving, it's becoming more and more less of a monolithic thing like an airport or a power plant. And it's coming into areas that's going to focus more in the day- to- day aspects of our lives.

Greg Campion: That was Orhan Sarayli, head of North America for Barings' Global Infrastructure Group. And this is Streaming Income, a podcast from Barings. I'm your host, Greg Campion. Coming up on the show, understanding the growing opportunity in infrastructure debt. Before we get into the conversation, remember you can follow Streaming Income on Apple Podcasts, Spotify, and if you'd like to watch the full video episodes on YouTube as well. Finally, make sure you are following Barings on LinkedIn, so you will be the first to receive our soon to be launch newsletter where credit is due. Where we'll be spotlighting people and portfolios and asset classes from high yield to private credit and everything in between. With that, please enjoy this conversation with Orhan Sarayli. All right, Orhan Sarayli, welcome back to the podcast.

Orhan Sarayli: Thank you, Greg. Great to be here.

Greg Campion: Yeah, excited to have you here. Good to have you here live and in person in Charlotte. I know you're usually in New York or on airplanes somewhere around the world, but it's nice to have you here in person.

Orhan Sarayli: No, it's great to be here and yeah, no, and I love to contribute to the infrastructure industry by using as many airports as possible.

Greg Campion: Nice. All right, cool. So let's get started. For any listeners maybe who did not hear our prior episode or not familiar with you and your team, can you maybe just start a little bit talking about your role, your background, and maybe just a little bit about the infrastructure team here at Barings?

Orhan Sarayli: Sure, happy to. I am the head of the North America infrastructure team here at Barings. That team consists of two different teams based in London and New York. We're about 14 people in total. And our goal is to try and bring the best of the infrastructure debt market to our investors. So what that means is we have to go out and find the deals. We have to originate and identify the best deals for them. We then have to underwrite and monitor them and make sure that they're performing the way they expect they're going to be performing. All within the context of trying to make sure that we are on top of where the industry is going and making sure our investors are happy with the performance.

Greg Campion: Awesome, great description. Okay, cool. So let's talk a little bit about, maybe we can define our terms, I guess, upfront. So I think infrastructure is a term that gets thrown around in a lot of different ways. A lot of people use it to describe different things. I think it's become trendy recently as well, maybe for good reason because there's a need for massive infrastructure. There's been huge spending in infrastructure space, but let's define our terms. Tell me a little bit about when you and the team specifically look at this investment universe of opportunities, what kind of makes the cut, what's defined as infrastructure? And then maybe we can talk about what doesn't make the cut.

Orhan Sarayli: It's a great question and we hear about this a lot when we talk to borrowers, sponsors, investors, really runs the gamut. And I think a great example of is when we recently posted for a job in our group to fill an opening, probably I want to say almost half the resumes came thinking it was for some IT architecture type role.

Greg Campion: Oh, okay. I wasn't even considering that definition of infrastructure, but I could see that.

Orhan Sarayli: Yeah, we had a lot of IT submissions and I think it is because infrastructure is a broadly used term and people do need to know exactly how do you define it and where those boundaries are. And we do think it's important to make sure that the boundaries exist because you do need discipline and need knowledge about the areas you're going to focus on. So we've been extremely, extremely disciplined about making sure that the spaces we cover within infrastructure are the spaces we cover and focus on and that we're not just doing the flavor of the day. So in that areas, for example, we define it within six subsectors. The first one I'd say, which is the largest, would be what we call economic infrastructure, which is really another name for transportation- related infrastructure. So that would be airports, toll roads, terminals, ports. And that is, again, probably almost 30% of our entire portfolio globally.

Greg Campion: Got it.

Orhan Sarayli: Then you have the traditional utilities and then you'll have power generation, which was fundamentally a spinoff from the utility space. There's oil and gas midstream and new biofuels midstream as well, which we throw in there. There's social infrastructure which are partnerships between government entities and private sponsors to build infrastructure needed for that government entity. And then finally, and one that's probably been growing the fastest over the last 10 years has been digital infrastructure, which includes data centers primarily nowadays, but it also includes fiber and it also includes towers. So that's the way we define infrastructure and that's where we stay within those boundaries as much as possible.

Greg Campion: Okay. That was a great description. Let's get into what's been going on in this space, let's say, over the last decade or so. I mentioned upfront, I think it's become sort of an in vogue place to invest or you just hear about infrastructure investing so much more in investment circles and even in the common parlance these days. But I'm hoping you can kind of just take us through what you've seen in terms of maybe the growth of the market or any big structural trends that are happening over the last decade plus that are really underpinning what your so much interest that we're seeing in this space right now.

Orhan Sarayli: Where do we start, Greg? I mean, in 10 years, which is around the time we established our group, there's been so much change that has happened probably net for the positive. But the first one I'll bring up is just the substantial growth of the private infrastructure market. At the end of 2014, I want to say the total volume of financing done was probably around 340 billion. And at the end of last year, it was over 770 billion. So a tremendous amount of growth in that 10- year period. I think that growth has been driven by, again, new and evolving spaces within those infrastructure areas that we defined within the sectors. Digital infrastructure will continue to grow. Some estimates speculate that there'll be as much as 7 trillion needed by 2030 to build out all of that infrastructure, primarily driven by data center.

Greg Campion: inaudible around that. But yeah, yeah.

Orhan Sarayli: It's amazing. It's amazing. And again, one thing that we also think about is infrastructure has changed a lot. It used to be that coal- fired plants dominated the landscape here and maybe they'll come back. But certainly, the fuel profile of electricity generation has changed globally and that moved towards more sustainable fuels is a trend that probably is not going away globally. And so, again, the OECD speculates that could be another 7 trillion alone globally to get to by 2030. So you're talking about 14 trillion in those two spaces alone. And the market at the end of 2024 was 770 billion. And then you add on about all the dialogue going on, whether it's government administrations, whether it's leaders of financial institutions, whether it's just people around that you sit and grab coffee with. Infrastructure continually comes and pops up in conversation. This is something that is going to continue to happen. This space is growing, it's evolving, it's becoming more and more less of a monolithic thing like an airport or a power plant, and it's coming into areas that's going to focus more in the day- to- day aspects of our lives. And that could be, again, just how we use our digital technology as we move about. It could be maybe how you get your own electricity now on your rooftop versus relying on the utility. But these things aren't slowing down. It's something that, again, has forced us to respond and react to, but it's also created a tremendous amount of opportunity.

Greg Campion: Okay. So huge macro tailwinds. We are all seeing a lot of headlines around massive infrastructure projects, particularly on the digital side, but in other areas as well, transportation, etc. How is all of this getting-

Orhan Sarayli: Financed.

Greg Campion: Right? So that's kind of big question and I think that leads into maybe the growing opportunity set for institutional investors. Because, I think, it's my impression that the banks were traditionally the major players in this market. Talk a little bit about that dynamic, and the idea of this funding gap, and the role that institutional managers and institutional investors are playing today in that broader picture.

Orhan Sarayli: Well, I know you talked about the 10- year horizon, but when we talk about infrastructure, let's just go back a little bit earlier than that. Let's go back 100 years, Greg.

Greg Campion: Okay.

Orhan Sarayli: 100 years ago, nobody talked about infrastructure financing because nobody needed to talk about infrastructure financings. The governments did all the infrastructure financing, or the utilities did all the infrastructure financing, or the railroads did the infrastructure financing. Well, those days no longer exist, right? When you have a scenario here where globally a lot of the governments except maybe a handful are running into budget issues and fiscal issues, the ability to build and maintain the infrastructure you have is already challenged. So what has historically been the primary source of funding for infrastructure historically, I think, is going to continue to be a challenge, and I think that's something that's going to creep globally more and more. Then the next layer is in the utility space. This could be cyclical, but we're definitely in a part of the cycle right now where the utilities have a lot of challenges. They're great challenges because they're all driven by growth. The electric utilities need to continue to grow, their grid and their systems, to evolve and adapt to a new AI world or one that requires more cleaner forms of energy. What worked in a centralized big coal- fired generating and nuclear- fired generating plant system doesn't work the same way from a distribution perspective and transmission perspective. So there's all this CapEx needed on the electric utility side to adapt to the new world order. And then you also are seeing there's a lot of improvement in transportation that's needed and that's going to take a village to sort of figure it all out. Long story short, this is going to require the private infrastructure universe to become a bigger and bigger part of it. And I don't think we're the only ones who feel that way. I think you can probably look at a number of different sources who all believe it is inevitable that the private institutional market is going to have to step in big time. The banks themselves have been incredible supporters and they continue to be probably the biggest source of capital for infrastructure projects, but they are also getting challenged in terms of meeting the velocity of the need for the capital coming. Again, when we're talking about, I point out that 7 trillion number on digital infra alone and 7 trillion for sustainable infrastructure, that's a lot of money for the banks to handle over a 5 to 10- year period. So again, it's going to take a lot of support across the world.

Greg Campion: Yeah, okay. So what are you seeing actually, what type of solutions are being developed, I guess? You hear about alternative asset managers playing perhaps new roles in this space, new kinds of partnerships developing that we haven't seen traditionally before. What are some of these, the creative approaches that you're seeing in the market today?

Orhan Sarayli: Well, it's an exciting time in my opinion because I think we're seeing a lot of dynamic thinking out there in the institutional market to try and address some of these needs. And you're seeing a very receptive audience from the owners of these assets. And again, when you think about an electric utility is not one infrastructure company, it's probably a subset of four or five different infrastructure companies. And so, the electric utilities are able to then carve out a subset of their portfolio and put it in a partnership with an institutional asset manager and create a vehicle there that, A, gives them the money to fund their CapEx needs. Probably because it's a discrete asset, will be able to get a valuation that is accretive to the selling utility. They still maintain operating control of the asset within that partnership, so they don't really lose anything. All they're doing is they're getting a minority partner in more of a passive way, and it's a better form of raising equity than going out into the capital markets themselves and raising the equity from the public market. So that's just one option out there. But the availability of institutional money allows all of these players who need the money, be it governments, or private entities, or publicly- owned utilities, what it's doing is allowing them to have many more options available at their disposal to be able to meet the growth needs of the space than they had 10 years ago.

Greg Campion: Interesting. Lots of innovation and creativity happening in this space right now, it seems. So if I were to sum it up, we've got a massive need for infrastructure development and infrastructure updates. We've got, therefore, a massive need for capital and financing for all of this. There's banks continue to play a major role, but increasingly institutional asset managers, alternative asset managers playing a role in solving this equation. Let's look at it from the sea of an institutional investor. Let's talk a little bit about the investor base for infrastructure debt. Maybe who's kind of investing there and how that's changing over time? When I think of infrastructure debt, I immediately think of the insurance investor base. They've got long- dated liabilities to match. There's traditionally been things like favorable capital treatment, et cetera, et cetera. It ticks a lot of boxes for that. And no surprise, as a subsidiary of MassMutual, we've been investing on their behalf in this asset class for many years. I'm curious, is it still kind of a insurance dominated market? Is that changing? What's going on with the investor base?

Orhan Sarayli: It's definitely changing. As you can imagine, as anything grows more in exposure as well as hopefully attractiveness, you're getting a much more diverse type of investor base coming into the infrastructure asset class. We still believe the insurance market is very long standing supporter of the infrastructure space. MassMutual alone has invested in infrastructure assets for decades even prior to the establishment of our group. So we don't think that's changing. If anything, we see the appetite from insurance companies continue to grow for infrastructure debt, and we are certainly hearing not only of increasing appetite from insurance companies in the US, but more and more globally as well. So I think the insurance company percentage of the total pie is shrinking because we are seeing, again, whether it's asset managers who then themselves invest with other managers as part of their ability to extend into asset allocation. So for example, there are a lot of retail- oriented institutions who would love to figure out a way to play an infrastructure. That's an area that really hasn't tapped the infrastructure market historically. That could be a goldmine in terms of creating a retail- oriented product like that. Let's not even focus that far out on the horizon. Right now pension funds, I think a lot of pension funds, if you look at what they target, whether it's called real assets or infrastructure, it probably runs from 2% to 5%-

Greg Campion: Of their total-

Orhan Sarayli: ...of their total asset allocation. With the numbers we're talking about, I don't think 2% to 5% is something that is going to be the long- term target, if you ask me. I think that number is only going to go up and you are seeing institutions start thinking about increasing their allocation towards infrastructure. Now, the portfolio performance, I think, is a factor. There are challenges with the type of investments we're making in that they're generally private, they're generally illiquid. So as long as those challenges are managed and monitored well, I think there will be more of a track record to draw interest from those investors. But I think between asset managers, family funds or high wealth type money, as well as other institutional investors like that, it's going to be an increasing pool of investors.

Greg Campion: What about sovereign wealth funds, I'm curious, who usually tend to take a long- term view on things. I think about some of these massive investors in the Middle East who are focused on big long- term projects and economic development. Do you see interest out of that kind of group?

Orhan Sarayli: I give a lot of credit to the sovereign wealth funds, and I'll throw in the Canadian pension plans in that equation as well. Many of those institutions were some of the earliest supporters of the infrastructure industry, mostly on the equity side, and they continue to be probably the biggest supporters of the infrastructure industry. I would say, a good amount of infrastructure equity capital comes from that base. We are absolutely seeing those players play a lot on the infrastructure debt side and increasingly increasing their presence in that space as well. The dialogue we're having with the sovereign wealth funds is not going away, that's for sure.

Greg Campion: Great. Now let's talk a little bit about the return profile for the asset class because my perception has been you traditionally think of infrastructure debt as more of an investment grade equivalent type of asset. We talked about how it's been traditionally been a favorite asset class for insurance companies. So does that equate to this is a lower return asset class and is that just something investors have to be okay with because there's other benefits like diversification, etc. Or how do you think about the return profile in the space overall?

Orhan Sarayli: Yeah, there is nothing you said there that I would say I have any disagreement over. There is a tremendous amount of opportunity for conservative investors like insurance companies to participate in very good investments in infrastructure and earn market yielding investments on the investment grade debt side. And like a lot of the other markets out there where investment grade dwarfs non- investment grade opportunity set for whether it's two- to- one, three- to- one, the bulk of the investment opportunity set in infrastructure is investment grade. That's always been the premise of why we built out the practice here to help support MassMutual's growth objectives in that area. But it is without a doubt, just one component of the infrastructure finance space. Like any other area, there are different ways to play it and we have increasingly added capabilities in the other areas of infrastructure. And the one thing I would say is infrastructure is still, especially infrastructure debt, it's still a relatively young industry. It's still figuring out where it needs to go to become a more credible investment alternative, particularly for institutional investors. And I think one of the challenges is we need to start being able to demonstrate and create more opportunities for investors to participate in higher yielding areas. So we've done that on the infrastructure debt side through a number of different vehicles. And I think the infrastructure equity universe will also say that there's been a lot of areas to demonstrate growth and value- add strategies to help get higher returns than you might normally think of. But generally, infrastructure, again, due to its low risk profile, it probably does fall within a return yield range on the equity side that makes it only applicable for certain investors. What we like to think on the debt side, however, is an investment grade instrument in debt for infrastructure we think might actually bring more premium over traditional corporate investment grade debt yields. And at the same time, we see that same sort of pickup on the non- investment grade side. So while on the equity side, one might be motivated to go for a lower yield and rate of return, we would argue you're going to see a better return for infrastructure debt than for other non- infrastructure debt opportunities.

Greg Campion: Okay. Is there enough opportunity to have enough exposure to build a large diversified portfolio in this asset class? It sounds like we're heading in that direction with some of the numbers you were talking about at the beginning of this conversation, but I just think about some of those challenges from an investor standpoint. How are you and the team thinking about helping them tackle those?

Orhan Sarayli: Yeah, I would say, there's no one answer for everyone. I think we do tend to see that infrastructure debt, for example. Sometimes it will fall under the fixed income group at a certain institution. Sometimes it'll fall into the real assets bucket of another institution. Sometimes it'll fall into the alternatives bucket of another institution. So there is definitely no standardized approach to infrastructure debt, and that is a challenge that I think we are trying to help address by coming out with more defined products that have specific objectives and then let the investors decide for themselves where it best fits. So we have the investment grade option that we offer up to investors. We have a non- investment grade strategy, and now we believe there are going to be future strategies as well to grow into, for example, a CLO infrastructure strategy. If I have one concern about where I think infrastructure debt has... Well, might have run into challenges is, a lot of the strategies, particularly on the higher yielding side, tend to come up with a closed- end fund type vehicle that has to hit a certain target yield and give the managers the money and they'll put it in 15 to 20 investments. And they're all non- investment grade and they hope they all perform so you can meet your return objectives. And that's really a legacy of how the infrastructure equity market was developed, but it doesn't really bring the diversity nor the broad depth of the infrastructure market to the investors. So there are investors who like that strategy and there is value to that strategy. But we also believe in order to meet the needs of the infrastructure industry, we have to broaden the base to be able to give something that meets every investor's needs in whatever bucket they put it into. We think an infrastructure CLO is going to be an important tool in that approach. I don't believe it's going to be limited to that. I think you're going to see need for numerous different ways to help investors reach that market. I think working with the rating agencies and working with the product laboratories within asset managers, it will all ultimately get there to broaden it. But when you think about what are the challenges some of these investors have, well, there aren't enough rated deals out there. Okay? That's an easy solution that someone should be able to solve. A CLO is just one way to address that. It's not the only way to address that. You might have banks who are holding more paper in the space but don't necessarily want to sell the paper, but they want to figure out different ways to offload risk. There are already solutions out there for that, that asset managers and institutions can participate in. So there's a large number of ways that asset managers can help investors fill the need for infrastructure and make sure that it meets their needs as well.

Greg Campion: Yeah, yeah. What I think is exciting actually is that I think some people may have perceived infrastructure debt as kind of a sleepier asset class or have traditionally perceived it that way. But if you actually look at what's going on, whether you're talking about some of these alternative asset manager partnerships with utilities. Some of these new innovations that are happening in terms of infrastructure CLO, which I might ask you to say a couple more words on because that was something that was announced recently that Barings is entering into a new partnership there. But it's exciting to see this type of innovation. And ultimately, it's about delivering the asset class to investors in a way, I think, that they want to get that exposure. So I think that's pretty exciting to see those developments, but do you want to say another word or two on the infrastructure CLO side?

Orhan Sarayli: Yeah. It is probably the most efficient and expedient tool available for us to be able to participate and give the investors the broadest reach within the infrastructure debt side that's out there. We think we're incredibly well positioned given what we have with our CLO team here and the infrastructure debt team that we have in place. We think the borrower universe is going to appreciate it and just give them another option. And we think it's going to create a lot of different ways for investors to meet their risk- reward needs instead of just, " Hey, here's a deal. It's double B, take it or leave it." Well, there are different tranches that an investor can now participate in depending on what best fits their need. And again, I think there are just elegant ways to do other iterations of something like that within infrastructure, and the industry is definitely going in that direction anyway. It's an exciting time. I'm definitely excited, and the opportunity set just continues to amaze me with how resilient the industry continues to be, whether it's interest rate shocks, whether it's pandemics, whether it's administration changes. There is just way too much momentum behind infrastructure to think that it's going away anywhere. Now, you may have nits about, well, maybe I think data center is a little, too much exuberance over data centers. Maybe renewables has its glory days behind them now. You could take a view, but as a whole, that's the beauty of the infrastructure, particularly the six sectors that we define it. There is no way all that space is going to run into a slump. It's going to continue to perform with a fantastic credit track record. It's going to continue to see growth and opportunity available. And it's going to continue to need capital from more than just the banks and guys like us. So the opportunity set is tremendous, in my opinion.

Greg Campion: I love it. You got me fired up now about infrastructure debt. Cool. Well, let's leave it there. I think this has been a really enlightening discussion. Appreciate you kind of taking us through the development of infrastructure debt, bring us up to speed on all these latest developments that are going on and talking to us a little bit about where we're going from here. So appreciate it, Orhan.

Orhan Sarayli: Great. Thank you for having me again, Greg.

Greg Campion: Thanks for listening to or watching this episode of Streaming Income. If you'd like to stay up to date on our latest thoughts on asset classes ranging from high yield and private credit to real estate debt and equity, make sure to follow us and leave a review on your favorite podcast platform. We're on Apple Podcasts, Spotify, YouTube, and more. And remember to follow Barings on LinkedIn for all of our latest updates. Thanks again for listening and see you next time.