Better the devil you know

Infrastructure is not private equity. This was the conclusion reached by many in the immediate aftermath of the global economic and financial crisis. It referred to two things:

One, that some infrastructure investors mimicked the behaviour of mega-buyout funds during the bubble and deployed investors’ money in ways those investors may have found surprising – and ultimately disappointing. Infrastructure – safe, steady returns – was not supposed to be surprising.

Two, that private equity fund structures were forced on infrastructure funds like a straitjacket. This meant, for example, the adoption of aggressive manager compensation models and ten-year closed-end funds. Many felt this was equally inappropriate (in hindsight, at least).  

Let’s consider the ten-year, closed-end private equity-style fund structure.

In the September 2010 issue of Infrastructure Investor, Kyle Mangini, global head of infrastructure at Industry Funds Management (IFM), made a compelling case for open-ended infrastructure funds.

Referring to the example of his firm’s acquisition of Vattenfall’s German electricity grid last year, he spoke of the patience required to wait two years before the deal came to fruition – and of how the firm was able to persuade regulators that this strategic asset would be in safe hands because – alongside its industrial partner Elia – IFM would be happy to hold the asset for a long time. IFM has, in fact, held some of its portfolio assets for as long as 15 years.

IFM, along with many other managers from its Australian homeland, has been successfully applying open-ended funds to infrastructure for many years. So the view put forth by Mangini – that infrastructure investing is best done patiently – was no sudden revelation. Within the placement agent world, a great deal of intellectual rigour has been applied to the task of creating infrastructure-specific vehicles that would perfectly address investor concerns. Indeed, conversations with limited partners to this day continue to elicit warm approval for this academic struggle towards a fund model that would allow infrastructure to wriggle free of the straitjacket and reach for a well-fitting suit.

But something appears to be happening that sits at odds with all this. Recent conversations with  placement agents and funds of funds managers – no more than a handful but, take my word, it’s a respected handful – point to the struggles of open-ended funds in the market to gain traction with investors throughout last year and into 2011.

To be sure, closed-end, private equity-style funds were also struggling for most of last year. Some of these are now thinking of admitting defeat and throwing in the towel. But for others, the second half of last year offered renewed momentum. One of these was the oversubscribed fund from Cube Infrastructure, which initially had an open-ended structure but only gained serious momentum when it switched to a 12-year life. The oversubscribed Antin Infrastructure fund also had a 10-year private equity-style structure. And this year’s most-talked about fundraising-to-come is the next private equity-style vehicle from Global Infrastructure Partners, said to be targeting $6 billion.

Infrastructure Investor hears of at least one open-ended fund in the market that has added a term giving investors the flexibility to liquidate the fund early if they vote for such action.

All of this points to investors applauding the theory of open-ended funds while failing to vote with their wallets. There are a number of reasons why this might be so. Investors take comfort from management teams incentivised to stay put – more likely when tangible rewards are achievable in a relatively short timeframe. Another point to consider is that placement agents note a new wave of money just starting to come into infrastructure from Asia – where investors may be less inclined to see infrastructure as an asset class distinct from private equity.

One final point: adaptations are being made to cater to infrastructure investors’ demands. Note, for example, the evolution of carried interest formulas linked to cash yield. Cash is king for many infrastructure investors, and it is important that this is recognised in manager compensation.

These tinkerings aside, LPs appear happy to admire efforts to give them what they supposedly want – while sticking with what they supposedly don’t.