Coming in from the cold

The US offers plentiful opportunities for those seeking respite from the crowded core market.

Once delegates at this week's Infrastructure Investor LP Summit in New York had had the opportunity to recover from the perishing cold – with temperatures at record lows for the time of year – the hearts of value add/opportunistic fund managers would have been warmed by a poll conducted in one of the early sessions. In a room well populated by limited partners (LPs), it showed that some 67 percent of voters believed more capital would be committed to such strategies.

Two reasons were put forward for this: one, that investors already have all the exposure to core assets that they want or need and are ready to dip their toes in other waters; two, that – amid fierce competition – returns in the core space have disappointed and investors have decided to tolerate somewhat higher risk in exchange for materially stronger returns.

If this capital shift does indeed take place, there is a question mark over how much capital can be absorbed. Many of the opportunities – or, at least, the best opportunities – are considered to be in the mid market, where the priority of some companies is simply to get non-core assets off the books – meaning that they will often settle for a decent rather than lucrative sale outcome. Some perceive the opportunity set to include even smaller deals (the “small to mid cap” space). Either way, one of the major benefits for fund managers is that direct investors find it difficult to access these kinds of opportunities, so competition is less intense than at the larger end.

In the US context, the shale boom provides a unique dynamic for mid-market deals, with a supply of midstream opportunities ranging from pipelines to the likes of treating and fractionation facilities. These transactions may have their challenges and nuances in relation to things like counter-party and commodity risk, regulation and contracts – but, crucially, there is no shortage of potential opportunities.

In keeping with the notion that LPs are now willing to take a little more risk if the returns make sense, the view was expressed that – where you have the right developer and the circumstances stack up – taking greenfield risk in the power sector is increasingly acceptable if it means a project can be successfully transitioned and packaged up for sale as a core asset.

Words of caution were also expressed, however, about the gradual move from core to value add, particularly in relation to whether value add is a credible strategy for a given fund manager or simply a flight from core. If the latter is the case, it raises the specter of strategic drift – and the likelihood of fund managers ultimately finding themselves well and truly out in the cold.