Introduction

Infrastructure financing is unique and distinct from any other type of financing since it is not only long term in nature (5 to 25 years) but also involves understanding of complex contracts in heavily regulated sectors.

Globally, it is the long term investors like pension funds, insurance companies, sovereign wealth funds, endowment funds etc. who fund this sector through capital markets with commercial banks primarily acting as arrangers. However, in this regard, India has been different since over 90% of funding to this sector has been through commercial banks and non-banking finance companies (NBFC) with exposure of this segment to infrastructure sector aggregating about ₹ 13 trillion i.e. over 90% of the total funding. NBFCs themselves get significant portion of their funding through commercial banks whose main source of funds is short term customer deposits. Thus, essentially short term deposits of retail investors have been used to fund long term infrastructure assets in India when ideally it should be long term investors like pension funds, insurance funds etc. who should fund this sector.

Source: RBI data, CRIIL and Bloomberg

It is projected that in the next 5 years, the sector requires ₹ 51.5 trillion of funding out of which about 50% is projected to be financed by private sector. Assuming a debt – equity ratio of 2:1, the total debt requirement would be ₹ 16.8 trillion, which will increase the exposure of banks and NBFC by around 130%, that too from a base that is already quite high, if no other investor class is roped in.

 

 

 

Funding requirement for Infrastructure Sector

Clearly, this is not sustainable and hence, there is a need to attract new investor class in this segment. At the same time, it is noteworthy that India has a large and vibrant pension and insurance industry, which has long term funds that can be invested in the infrastructure sector. However, for historical reasons this segment has stayed away from this sector leading to entire load of funding with commercial banks and NBFCs

The insurance and pension fund industry in India is estimated to have corpus of about ₹ 30 trillion as on FY 2014 growing @ 14% per annum. Most of this corpus is now invested in low yielding GOI securities which may not be able to deliver required return for this segment and thus, this “investor class” also needs a new “asset class” that can provide better risk adjusted return.

Size of pension and insurance industry in India

Source: EPFO and IDRA Annual Reports

“Infrastructure debt” in an “asset class” which can bridge this gap very effectively since it can provide long term stable returns with low co-relation to any other type of investment. However, selection of right asset is the key and it is imperative to entrust the asset selection and management to the experts who understand the sector and have experience in financing the infrastructure sector. Expert fund managers can also play important role in mobilizing funds from offshore long term investors since they can identify investment opportunities faster than other investors and also articulate the same suitably to sophisticated offshore investors.

It was with this intent to channelize funds from domestic and international pension insurance funds into infrastructure sector that Government of India conceptualized infrastructure debt funds (IDF). These are under 2 formats – NBFC format and Mutual fund format. The brief details of these formats are given below:

 

 

IDF under mutual fund format (IDF MF): Broad Structure

The regulatory and investment architecture of IDF – MF is akin to existing operating frameworks for other mutual funds in India as explained below:

IDF MF: Regulatory Framework

As can be seen above, under the mutual fund structure, Asset Management Company (AMC), on behalf of the IDF Mutual Fund, makes the investment decision and monitors the investments. The trustee of the fund monitors the activities of AMC and is responsible for the Governance oversight. As per regulations, the trustee company needs to have at least 75% independent directors so as to facilitate independent and effective supervision of AMC. Further, as per regulations even AMC needs to have 50% independent directors. Offshore and domestic investors who invest in IDF are issued units for the investments made. From the corpus so raised investments are made from the fund by AMC in the form of debt security (non-convertible debentures or bonds).

The units issued are denominated in local currency and the fund raise is through close ended schemes of 10 to 12 years, which are divided into 3 to 4 series having maturities ranging from 5 to 12  years to facilitate returning funds to investors at regular intervals

The units of the IDF MF are compulsorily required to be listed on the stock exchanges offering exit option to the investors. The AMC announces the NAV of the fund periodically the value of which is dependent upon the returns made from the investments made by the fund in various debt securities

Value Proposition to Investors

Today, capital market in India is bipolar in nature - on one hand, we have equity as an asset class with expected returns of around 20% and on other hand, we have debt as an asset class which is mainly confined to Government of India securities and to small extent, AAA corporate bonds with long term expected return of about 8 to 9%.There is no asset class, which is in between the two in terms of risk and return profile. IDF - MF can fill this space effectively as explained below:

Out of the total banking and NBFC’s exposure to infrastructure sector (₹13 trillion) about 10% is in operating infrastructure projects were operations have stabilized. These projects are typically rated in the range of BBB to A- but are past key implementation risk. Since, these are housed in special purpose vehicles and are more often than not monopolistic in nature, it is expected that with time, as demand for the their services/product  goes up and the debt comes down, credit rating of these projects would go up.

IDF MFs would primarily target these kind of opportunities – it would invest in operational infrastructure projects, in the form of tradable debt security, when their rating are in the range of BBB to A and then nurture it for some time. Once the rating is upgraded to the range of AA to AAA in 3 to 4 years, it would trade these assets with mutual fund / insurance or pension sector and earn handsome capital gains. These capital gains along with contracted high coupons commensurate with rating of BBB to A when the investments are made would lead to superior returns for IDF MFs. Since typical fund tenure of IDF - MF is 10 to 12 years, it may be possible for them to have up to 2 cycles of capital gains leading to generation of attractive risk adjusted returns.

IDF MF: Value proposition to investor

Source: Bloomberg, Cogencis, IL&FS IDF Estimates

With the changing economic and political environment in India, as various implementation issues are resolved, projects in operating space would go up widening the investment horizon of IDFs. This will also help in development of bond market in India since with growth of IDF MF more and more bond issuance would happen across various rating bands and would get traded in the market.

Eventually, IDF MF would also be able to pursue mezzanine debt strategy for sophisticated investors were it could finance projects, needing last mile funding, with suitable debt instruments having equity kickers. This would be relatively high risk strategy with potential for equity like returns.

To summarise, IDF is a unique financial instrument in Alternate Asset Class space which can, not only provide long term investors a suitable investment avenue to generate long term stable returns with low correlation to traditional asset classes, but also provide infrastructure projects with additional Financing Avenue to optimize their debt structure. It is an initiative of national importance and can go a long way in helping meet the demands of infrastructure sector in India.

IL&FS Infrastructure Debt Fund (IL&FS IDF)

IL&FS IDF is under mutual fund format with IL&FS Infra Asset Management Ltd (IIAML) acting as the Asset Management Company (AMC) and IL&FS AMC Trustee Company Ltd acting as the Trustee Company.

86.6% of IIAML is held by IL&FS Financial Services Limited, 7.7% by Life Insurance Corporation of India (LIC), one of the largest life insurance companies in the world and balance by insurance companies like GIC, United Insurance and National Insurance. The fund was inaugurated in February 2013 by the then Finance Minister, Mr. P Chidambaram. Since then it has already completed 2 successful launches and its current corpus of committed funds is ~₹ 14.0 billion. The first launch of the fund was rated “AAA-idf mf” by both CARE and India Ratings while the second launch has been given “AAA-idf mf” by India Ratings. This rating denotes the strength of the credit protection factors embedded in the fund’s investment policies, expertise and experience of the sponsors and investment managers

After the closure of its first launch comprising 3 series of 5, 7 and 10 years, the fund achieved the distinction of being the first IDF to raise funds from investors and deploy the same. It has achieved market leadership in its short span of existence and is poised for exponential growth. IIAML, the AMC managing IL&FS IDF has already achieved break – even in the 1st quarter of this financial year.

The units of the IL&FS IDF are listed in National Stock Exchange and are freely tradable giving exit option to investors.

The fund has a long term tie-up with LIC in the form of MOU as per which LIC has not only taken stake of 7.3% in the AMC but also committed to invest up to 20% in all the launches of IL&FS IDF. Apart from this it also has nominated one director in the board of IAML.

The fund has started making investments since Dec 2013 and has already invested / committed investments in a number of projects. It has built excellent portfolio of assets till date.

IL&FS IDF ASSET PORTFOLIO


In January 2015 the fund has launched its 3rd scheme with intent to target domestic pension funds and insurance companies. This fund would only invest in only those assets, which are rated “A” and above and would significantly rely on asset churning (investing with intent to sell down on positive credit and interest rate event) to pursue superior returns.

The objective of this article is to provide information on the constitution of IL&FS Infrastructure Debt Fund (“IIDF”) and update on the infrastructure sector to its recipient and not intended to form the basis of or to induce any decision regarding investment in IIDF
Each recipient of this article must make its independent assessment of the IIDF/AMC and its sponsor with regard to the relevance and adequacy of the information contained herein, and should make independent investigation that it deems necessary, to determine its interest in participating in any investment. This article is not and should not be construed as an invitation or recommendation by the AMC. The views expressed in this article are that of the Author alone and neither the Author nor the AMC /IL&FS Financial Services Ltd (IFIN) /Infrastructure Leasing & Financial Services Ltd (IL&FS) nor any of their respective affiliates, advisers or representatives shall be liable whatsoever (in negligence or otherwise) for any loss howsoever arising by the recipient. Past performance is not necessarily indicative of future performance.  Recipients are urged not to place any undue reliance on these forward-looking statements, which are based on the current views on future events
For additional information on the fund, please refer to the Private Placement Memorandum (PPM) and Statement of Additional Information (SAI). Mutual Fund investment are subject to market risk. Please read all scheme related documents carefully before investing

 

Manish Chourasia

Manish Chourasiais the Chief Executive Officer of IL&FS Infra Asset Management Limited (IIAML), Mumbai
IIAML is the AMC for IL&FS Infrastructure Debt Fund (IL&FS IDF), the first IDF – Mutual Fund in India.

 

 


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