Big institutions are getting excited about infrastructure debt. It seems that wherever you look these days, commercial real estate is being touted as a great investment proposition.
A major driver behind this phenomenon is escalating demand among yield-hungry institutional investors, such as pension funds and insurers, for the long-term inflation-linked stable returns that infrastructure debt offers.
And financing must continue to grow. According to official estimates, $15 trillion is needed to fund projects across the EU, US and Asia by 2020. But at the same time, cash-strapped European banks are retreating from long-term projects as they continue their post-crisis quest to deleverage, which in turn has created a funding gap.
It seems like the perfect storm.
Institutional investors are certainly capitalising on the opportunity to make inroads into what has traditionally been a bank-dominated sector. According to one report from Standard & Poor's, institutional investors – or so-called shadow banks – will lend $25 billion to projects in Europe during the course of this year. Insurance companies, pension funds, mutual funds and endowments together hold an estimated €13.8 trillion ($8.3 trillion) of assets - more than 100% of Europe's GDP.
There's just one fly in the ointment – the rise of non-bank financing in a sector that these institutions don't fully understand risks creating a bubble that could lead to another financial crisis.
Indeed, in the run-up to the last financial crisis, prices for acquisition financing inflated up to six times above normal levels. And these non-bank financial intermediaries are notoriously opaque. Although they provide similar services to conventional banks, shadow banks are not – at present – subject to the same strict level of regulation.
Differences between the capital, leverage, liquidity and transparency regulations governing shadow banking intermediaries, and the stricter regime governing banks, effectively creates a two-tier system of regulation, according to many. But equally, the risk-averse nature of institutional investors acts as a natural levelling factor, preventing excessive growth.
However, as the Financial Times recently observed, investing in infrastructure is ultimately an investment in an operating business. If poorly managed, or if the economy slows, it can lead to disappointing results.
In an age when neither bonds nor equities can be relied upon to provide returns, investors' attraction to project debt is understandable. But in this case, it seems that investors would be well-advised to look before they leap.