Core, core-plus, opportunistic: what’s in a name?

While no one can dispute that infrastructure, as an asset class, has arrived, the labels used to segment the market – as well as the strategies they symbolise – can spark some passionate debate.

The industry has come a long way since one fund manager told Infrastructure Investor his firm would be dropping the ‘infrastructure’ label because it had proved unhelpful when fundraising. One only needs to look at Global Infrastructure Partners, which raised a record $15.8 billion for its third infrastructure fund in a little over a year, to get a taste of how much things have changed in the past decade.

Between then and now, the asset class has matured, has become established and continues to draw capital from an increasing number of investors. Last month, a survey by Global Infrastructure Hub and EDHECinfra found that more than 90 percent of the 186 investors surveyed intend to increase their commitments to infrastructure over the next three to five years.

But the changes that infrastructure has undergone have led some in the industry to question the usefulness or relevance of labels such as core, core-plus, and value-add/opportunistic – tags that have been widely used and were borrowed from the real estate sector.

“Let’s say we go back 10 years, when we were at a very early stage of infrastructure being established as an asset class,” says Ross Israel, QIC’s head of global infrastructure. “One of the things that occurred during the education period was people trying to explain this very non-homogeneous asset class. It comprised a very diverse set of sectors and it was across a lot of geographies.”

Asked whether these labels mean the same thing today as they did when they were first adopted, Mathias Burghardt, head of infrastructure at Ardian, responds: “What we perceive in the market is that when we are at a low point in terms of price, people tend to focus on what we call essential infrastructure – airports, roads, bridges, regulated water utilities.

“When assets become scarce because there’s more competition, managers then look to more hybrid transactions – such as facility management companies, for instance,” Burghardt continues. “What seems to change over a cycle is the name but not the concept. Back in 2005-07, people called it hybrid infrastructure, now they call it core-plus. But, again, it’s a different name for the same thing.”

Core-plus vs value-add

Duncan Hale, global head of infrastructure at Willis Towers Watson, has little use for the core-plus label.

“I really don’t understand core-plus,” he says. “I’ve been in the market 15 years and it seems to me that core-plus is a definition that’s been created by managers to justify either being paid higher fees as a core manager or, if they’re a value-add manager, trying to appeal to people who are averse to greater risk.”

The brokerage firm segments the infrastructure sector into core and value-add or opportunistic – it has no core-plus category – by looking at pricing power.

“The key question is whether the specific asset has pricing power today,” Hale explains. “If it can demonstrate that, then we classify it as a core asset. Value-added assets are those that don’t have pricing power currently, but that can be developed in some way to demonstrate pricing power in the future,” he adds.

Asked whether pricing power is the same as having monopolistic characteristics, Hale replies: “Yes, monopolistic in some shape or form. So, assets that have a monopolistic supply on the one hand and an innate demand on the other.”

A stadium, for example, has a monopolistic characteristic in terms of supply but the demand may or may not be innate. “There may be reasons why people wouldn’t use the stadium for instance,” and why the asset would not be considered core, according to Hale.

“Back in 2005-07, people called it hybrid infrastructure, now they call it core-plus”

While the term core-plus, and the strategy associated with it, did not elicit as strong a reaction from the other infrastructure experts Infrastructure Investor spoke to, the response was nonetheless mixed, as this segment of the market can encompass anything from telecoms to car parks to launderettes to crematoriums.

For Burghardt, whose firm invests in essential infrastructure, straying beyond traditional infrastructure assets is to be avoided.

“We see that it used to be an exception – people doing deals that are not infrastructure – such as facilities management, launderettes or that type of thing,” Ardian’s head of infrastructure comments. “And if too many managers go down this route then people will tend to say: ‘Well, then is that infrastructure?’.

“There is a risk that some investor will no longer understand the difference between private equity and infrastructure,” Burghardt continues. “For me it’s a different play. It doesn’t mean that it’s less interesting, but if people want to do private equity then they will not look for 15 percent IRRs, they will look for 20 percent.”

A broadening definition

Anish Butani, infrastructure director at bfinance, takes a different view: “It’s a debate that has dogged the sector from the beginning,” he says, in response to whether the emergence of niche strategies can negatively impact infrastructure as an asset class. “New sub-sectors will always be questioned in terms of whether or not they are really infrastructure.”

One such sub-sector is motorway service stations. “Ten years ago, there was a big question mark hanging over these assets as to whether they really represented infrastructure,” Butani says. “It really beggars belief that today it’s almost taken for granted that, yes, these assets have proved themselves as being part of the infrastructure asset class.”

Butani cites Tank & Rast, a leading motorway service concessionaire in Germany. Private equity firm Terra Firma acquired the company in 2004. Three years later, the private equity firm sold a 50 percent stake to an infrastructure fund managed by Deutsche Asset & Wealth Management. In 2015, the company changed hands again, this time acquired by several institutional investors – Allianz Capital Partners; Borealis Infrastructure Management; Infinity Investments, a wholly-owned subsidiary of the Abu Dhabi Investment Authority; and MEAG, Munich Re’s asset manager.

“I think there will always be new sectors that emerge and I don’t think that LPs or investors are necessarily concerned by the name or type of asset – whether we’re talking about laundromats or cooking oil – though these are clearly stretching the definition of infrastructure in a new direction,” Butani remarks. “When they’re looking at infrastructure, they’re looking at it from a risk perspective – will owning these assets achieve the desired outcome of the infrastructure allocation? I think as long as the downside risk is protected and this is seen as something that can demonstrate the stable, long-term characteristics of infrastructure investment with a credible exit strategy and returns being commensurate with risk being taken, then a certain sub-set of infrastructure funds will look at these types of assets,” he adds.

QIC’s Israel agrees that new infrastructure sub-sectors will emerge as a result of the changing nature of core sectors.

“You can look at the telecom sector and the fact that telecom towers were not a core piece of infrastructure 40 or 50 years ago, but the explosion of the mobile phone has made those assets a core piece of infrastructure; the same with fibre-optic cables,” he notes.

Like Ardian’s Burghardt, Israel points out that the extension of the infrastructure definition has occurred before – when returns have been low and the market has become more competitive.

“But it comes back to the discipline of the investor to keep reviewing what infrastructure characteristics they’re looking for,” Israel stresses. “It doesn’t mean that some of those assets can’t be actively structured to represent those types of characteristics, but they may not be with the essential barriers to entry, wider EBITDA margins, the robustness of the return on the downside, the inflation protection many people seek through the asset class – so you can see that there’s a style drift.”

“I really don’t understand core-plus. It seems to me that core-plus is a definition that’s been created by managers”

Burghardt strikes a more cautionary tone in regard to style drift.

“In my view, the next crisis will discriminate between people doing real infrastructure and not real infrastructure,” he says. “The problem isn’t doing private equity-type deals, it’s doing private equity and combining it with infrastructure structuring that is the problem. For example, they leverage the company during a peak in the cycle, but when there is a downturn, this asset, which doesn’t have the same resilience as infrastructure, will lose money,” he continues. “So, I think some of the fund managers will disappear in the next crisis, while others will follow their strategies to the ultimate consequence and become private equity managers.”

A different perspective

Another way the infrastructure sector has been segmented over the past decade, is geographically, according to Israel.

“A lot of managers and GPs have presented geographic solutions to investors, moving away from the core, core-plus and opportunistic metric,” he says. “So, it’s evolved geographically and then it’s evolved with the development of investment strategy.”

According to Israel, investors are looking for differentiation. “I think that’s increasingly coming in via sector segmentation and a desire for a greater understanding from an asset management perspective on where value may be added,” he says.

Adding value is one of LPs’ main concerns, bfinance’s Butani says. “Investors really want to know about the ability of a manager to add value. They know that it’s a relatively expensive asset class and an asset class that has performed well over the past 10 years. But looking forward, investors really want to know and be certain about a manager’s ability to add value and justify those relatively higher fees.”

Speaking of fees, Hale, of Willis Towers Watson, believes that the high fees – along with a lack of discipline – that prevailed in the years leading up to the global financial crisis, are one of the main reasons co-investment strategies and club structures emerged as an alternative to funds.

“New sub-sectors will always be questioned in terms of whether or not they are really infrastructure”

While Hale acknowledges that co-investment strategies will be “a big thing for a very small part of the market [the largest investors]”, he believes that most investors would prefer to invest in funds, provided  managers can demonstrate they have the necessary discipline and that the fees they’re charging are good value for money.

“If you can demonstrate those two things, I think funds will definitely continue to be the key part of the market,” Hale states.

For Burghardt, co-investments – while not a broader trend – are a specific feature of infrastructure.

“There is a need for some investors, on top of their fund allocation, to access certain deals that will help shape their portfolio,” he explains. It’s not just a matter of fees, according to Burghardt; it’s also a matter of strategy and objectives.

“Some people want to buy and hold forever. Some people want to buy and hold but at some point maximise their returns. Some people are desperate for yield while others are more agnostic,” he comments. “Making all of these people happy is one of our biggest challenges. Co-investments are a way to do that.”

The shape of the future

So, what can investors expect from the asset class going forward? Certainly, more changes and an ongoing evolution.

“I’m sure there will be a new set of names as well in the future,” Israel says. “But as more performance gets recorded and the benchmarking becomes greater, the asset class will – I think – define itself further and that will be a sign of its maturity as you have seen in real estate. The proliferation of core, core-plus, opportunistic, residential, commercial, industrial, special opportunities, etc. – we’ve seen this elsewhere,” he comments. “It’s a sign of portfolio construction evolution and investors’ focus on matching more specific objectives from their infrastructure allocation, followed by managers and vendors trying to position assets for their specific outcomes.”

Butani also expects the definition of infrastructure to continue to expand as society evolves, needs change and technology advances.

“I think that managers are going to have to work harder to identify the long-term assets of tomorrow,” Butani notes. “That means venturing into somewhat unknown territories today.”