Infrastructure funds have not performed well and will need to adhere to new institutional investor preferences if they are to live up to the “significant” role they have to play in the future of infrastructure finance and development.
That was one of the messages delivered today by Anthony Rabin to a standing room-only gathering of the infrastructure finance industry at Infrastructure Investor: Europe in Berlin.
“Although infrastructure is an asset class with a slow burn, with success measured largely on disposal, infra fund performance hasn’t been great, either. In fact, a significant number of funds have shown negative values, particularly the newer ones having to buy assets in an increasingly competitive marketplace,” Rabin said during the conference’s opening keynote.
Rabin’s remarks come as Balfour Beatty, a major UK developer of infrastructure projects, is making its first foray into the infrastructure fund space. In November, Infrastructure Investor broke news that Balfour Beatty will make a seed investment in an infrastructure fund that will seek to raise between £500 million (€597 million, $782 million) and £750 million.
Rabin blamed the lackluster performance of infrastructure fund managers in part on strategy drift, whereby fund managers “go outside of their areas of expertise” and invest in assets that they don’t know well. He also said it was “fashionable for a while” for infrastructure funds to believe that “transportation was a relatively involatile asset class”.
“The global financial crisis, or GFC as we now must call it, has showed much of the world that transportation is in fact very closely correlated with GDP and the macroeconomic environment,” Rabin said.
Rabin also blamed a false belief that “leverage is a free good whose only function was to enhance the returns of those fund managers clever enough to pile on more debt into the supermarket trolley”.
“As one who has had the work of Modigliani and Miller beaten into him at an early age, I always found that a bit surprising,” he commented, referencing the work of two Nobel Prize-winning economists who theorised that the value of a firm is independent of whether it chooses to finance itself with debt or equity (Modigliani and Miller’s work also showed the tax savings of debt made it rational for corporations to maximise their debt loads).
Despite the lackluster past performance, Rabin insisted that funds have a “significant” role to play in the development of the world’s infrastructure. He based his optimism on the fact that “particularly in the US”, infrastructure as an asset class “appears to be achieving greater recognition with investors”. Over-leveraged corporations will also become sellers of assets, which will provide infrastructure funds a steady stream of dealflow, Rabin said.
But, given their past experience with fund performance, limited partners “are going to be a great deal more selective of their general partner managers”. Rabin said fund managers can position themselves to win commitments if they adhere to four key principles: a focused investment strategy, ability to originate deals, an appropriate governance structure and the ability to add “real value” to an investment through cost savings, enhanced revenues or higher productivity”.
“The market is a much harder place in which to operate,” Rabin said.