Focus on Project Bonds in emerging markets

When a new airport is built, a solar park starts generating energy or a motorway network is extended to open up a region, these projects don't just happen. Behind every essential infrastructure lies a major financing challenge. States, often constrained by budgetary limits, can't carry everything on their own. This is where project bonds come in, a financing solution that enables investors to play an active part in the development of strategic assets, while enjoying an attractive return.

Project bonds are specific debt instruments issued to directly finance strategic infrastructure: ports, airports, renewable energies (solar, wind, hydro), and energy projects such as FPSOs (Floating Production Storage and Offloading).

In a world of uncertainty, holding physical and strategic assets is a resilient approach. The infrastructure financed by project bonds - ports, airports, renewable energies (solar, wind, hydro) and transport infrastructure - is essential to the economic development of emerging countries. These investments not only improve connectivity and access to essential resources, but also create local jobs and strengthen the energy and industrial sovereignty of the regions concerned.

Project bonds benefit from a solid security framework, thanks to multiple guarantees that reduce credit risk and boost investor confidence. These bonds are generally backed by the assets they finance, providing tangible cover in the event of default ("senior secured notes").

What's more, these projects often benefit from the support of major international financial institutions, such as the World Bank or the European Bank for Reconstruction and Development (EBRD), helping to reinforce their economic viability and long-term stability. Project bonds are also distinguished by their ability to align the interests of investors and local stakeholders, thus guaranteeing a lasting economic impact and rigorous management of the infrastructures financed.

Projects are generally defined and secured by a long-term contract (e.g. airport concession contracts, PPA contracts, etc.) which defines the terms of sale with the off-takers. Unlike corporate bonds, which can finance a variety of objectives (capex, acquisitions, dividends), a project bond serves exclusively a given project. This ensures greater transparency and better control of financial flows. What's more, rather than repayment at maturity ("bullet"), project bonds are often "sinkable", with progressive repayment over the life of the bond aligned with expected future cash generation. This structure significantly reduces refinancing risk at bond maturity. The financing structure includes reserve accounts guaranteeing the availability of the cash needed to service the debt. The project sponsors are also financially committed, providing an incentive to ensure the economic viability of the infrastructure financed. Strict financial covenants defined in the offering memorandum govern the management of the project, imposing restrictions on additional debt and protecting the financial stability of the issuer.

Project bonds enable us to gain exposure to sectors that are poorly represented in the traditional high-yield bond allocations of developed markets, as this type of bond is generally rated investment grade, or these projects are financed by infrastructure funds via private debt. In the universe of emerging market corporate bonds, this type of project generally sees its rating capped by that of its sovereign, so these issuers are impacted by their zip code despite their quality profile.

Moreover, project bonds offer an attractive yield premium, also because they are often issued by new entrants to the bond market. This phenomenon, known as the "new issue premium", reflects the need for these little-known issuers to attract investors, thus creating an additional yield opportunity.

At first glance, these bonds may appear highly leveraged, which may deter some investors. However, closer analysis reveals an accelerated deleveraging mechanism. Initial indebtedness is naturally high, as the funds raised are immediately injected into the project. However, the structure of these bonds is designed to guarantee rapid debt repayment: the cash flows generated are directly allocated to repayment of the borrowed capital. This alignment between cash flow generation and debt servicing gives project bonds a more controlled risk profile than might appear at first glance, while maintaining an attractive return for investors.

Project bonds are often based on concession contracts or power purchase agreements (PPAs) with public or semi-public entities. An unfavorable regulatory change, a modification of the concession conditions, or a decision by the off-taker not to honor its contractual commitments may affect the economic viability of the project and the issuer's ability to service the debt. This risk is particularly acute in jurisdictions with unstable legal and regulatory environments. To mitigate this risk, it is essential to assess the solidity of the contractual framework, the associated guarantees and the track record of public counterparties.

Beyond these regulatory and contractual uncertainties, project bonds are also exposed to the risks inherent in each phase of the project. From design to construction and operation, each stage presents its own specific challenges. The construction phase is generally the riskiest, as any unforeseen delays or cost overruns can only be absorbed by the project's future cash flows, once it is operational. It is therefore essential to analyze the solidity of the sponsor and the expertise of the operator upstream, to ensure that they are capable of bringing the project to a successful conclusion.

The emerging universe represents 85% of the world's population and 75% of total greenhouse gas emissions. By financing green infrastructure (wind farms, solar power plants), project bonds contribute to the improvement of local infrastructure and impose strict governance standards. By integrating ESG criteria, project bonds enable investors to adopt a responsible investment approach. In particular, these instruments are in line with several of the United Nations' Sustainable Development Goals (SDGs):

What's more, these obligations often include strict ESG reporting mechanisms, ensuring that funds are allocated transparently and aligned with sustainable commitments.

India fully embodies the dynamic energy transition underway in emerging countries. The country had around 203 GW of installed renewable energy capacity at the end of 2024, and is aiming for 500 GW by 2030. This ambitious trajectory reflects the country's strong political will and the sector's growing attractiveness to international investors. It goes hand in hand with a massive need for green infrastructure - solar farms, wind farms, storage solutions - which can be efficiently financed by project bonds.

Players such as Continuum Energy, Greenko and Sael illustrate this dynamic: these Indian companies develop and operate large-scale renewable energy projects, often backed by long-term power purchase agreements (PPAs), making them eligible for structured bond financing. These instruments make it possible to align financial returns with environmental impact, contributing directly to the achievement of the Sustainable Development Goals: access to clean energy (SDG 7), promotion of sustainable industrialization (SDG 9) and combating climate change (SDG 13).

At IVO Capital Partners, our bad-country/good-company approach is particularly well suited to investing in project bonds, which account for 19% of our IVO EM Corporate Debt fund and 21% of our IVO EMCD Short Duration SRI fund. This universe combines discipline, security and yield, offering an opportunity for discerning investors seeking to combine impact and performance.

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