Beating the J-curve

Being seeded and providing predictable yield from day one may prove to be the keys to success for new infrastructure funds.

Prospects for new infrastructure debt funds haven’t exactly been swell recently. While there is a general consensus that new sources of debt are needed to help fund infrastructure, debt funds – widely acknowledged as part of the solution – have so far failed to truly click with limited partners (LPs).

For every Westbourne Capital that raises A$1 billion (€1.03 billion; $746 million) there’s a Hadrian’s Wall still struggling to raise money. Of course, part of the difficulty debt funds have encountered with LPs is that they are new and challenge LPs to get their heads around different structures. 

If market rumours are to be trusted, Hadrian’s Wall’s proposition – to facilitate senior debt funding for infrastructure projects in the capital markets by providing subordinated debt positions within senior-ranking infrastructure bonds – has been deemed by some LPs as “too complex”. 

So it may be significant that two of the most ambitious recent entrants in the debt fund category – Barclays’ £500 million (€571 million; $790 million) senior debt fund and independently owned Sequoia Investment Management Company’s €1 billion debt vehicle – are coming to market with simplified structures and a pledge, to quote Barclays’ David Cooper, “to deliver returns to investors quickly”.

In Barclays’ case, its debt vehicle comes seeded with £200 million of assets from Barclays Corporate, to help the fund get started. Sequoia is taking that concept a step further by dumping loan origination entirely. It has instead partnered with three banks which it deems “preferred originators [of assets]”.

Time will tell if these approaches will be more successful than previous attempts, but the trend of starting new vehicles with significant seed assets and security of supply is gaining traction with some LPs. Just witness the success, on the equity side, of recent, so-called developer funds.

In a keynote interview to be published in the November 2011 edition of Infrastructure Investor magazine, the co-heads of the John Laing Infrastructure Fund stressed that one of the advantages of its fund was that “there was no sitting around with idle cash – we were fully invested, with yield straight away […]as soon as we raised the money”. 

On its website, Sequoia promises to reduce “any drag on investor returns because of a slow ramp-up that is often a characteristic of infrastructure sector investment”.

All of which points in the same direction: new infrastructure vehicles are gunning for the J-curve – “the theory that the internal rate of return (IRR) of a fund will be low in its early stages, but then, as the firm becomes more stable and profitable, the IRR will increase,” in investing glossary’s definition – and touting this as a selling point.

In a slow-growth world, beating the J-curve counts for a lot. So too do security of supply and predictable returns, but let’s leave that for another time.