Cutting out the middle man

Should infrastructure fund general partners (GPs) feel threatened by the emergence of innovative arrangements between limited partners (LPs) and developers that cut out the ‘middle men’, i.e., the GPs? The answer is yes – or at least, more so today than yesterday.

And that’s because today came news that PGGM, the large Dutch pension fund, has established a joint venture with Dutch developer BAM PPP – the inelegantly named BAM PPP PGGM Infrastructure Cooperatie – to invest €390 million in social and transport PPP projects across Europe.

This partnership is interesting in its own right, but also because it follows a similar deal that PGGM struck with the UK arm of Australian developer Lend Lease in December last year – this being a 28-year fund with a five-year investment period to which PGGM committed £220 million (€263 million; $348 million). Both arrangements involve PGGM funding existing PPP investments – which get transferred into the partnership/fund – as well as future projects to be undertaken by the developers.

They are also part of a trend towards what are loosely known as ‘developer funds’, incorporating the likes of the listed John Laing Infrastructure Fund and the brownfield fund being raised by Balfour Beatty.    

The fact that PGGM has entered into a second such arrangement is informative. Either (most likely) the Lend Lease deal was never intended to be a ‘one-off’ and PGGM from the outset saw this type of arrangement as something that could be struck on a repeat basis. Or (less likely) it did indeed intend a ‘one-off’ but has been so impressed in its dealings with Lend Lease that it quickly decided to repeat the experience.

From the developer perspective, such arrangements offer answers to two niggling questions. The first: what to do with the big equity stake portfolios they have built up as a result of their success in bidding for projects – stakes which are non-core and do not sit easily on the balance sheet? The second: how to attract capital to keep fueling the future deal pipeline? With LPs such as PGGM prepared to come to the party with funding for legacy and future investments, both questions are answered.

For LPs, such arrangements tick a lot of boxes. Once through the construction phase, PPP/PFI equity investments offer yield, inflation hedging, benefit from government guarantees and offer steady (if unspectacular) returns over the long term. Also, crucially, fees will be on the low side – and very much lower than you would find in closed-end private equity-style infrastructure funds. An inside source at Lend Lease recently joked to us that no one in the organisation would be retiring to the Caribbean on the fees/carry generated from its arragement with PGGM – while declining to provide numbers.

At this point, closed-end fund managers will jump in and point out that they get paid decent fees and carry for a reason – mainly to do with the asset management skills that drive performance. They will argue that developers are simply not incentivised to look after the assets well. One counter-argument lies in the fact that, returns wise, no one is looking to shoot the lights out with mature PPP/PFI assets. Another is that developers will often be responsible for facilities management, and this is how a close relationship with the assets is maintained.

At the moment the PGGM-type arrangements are still rare. Not least this is because you need a sophisticated investor such as PGGM, well versed in the infrastructure asset class, to understand their benefits. The source at Lend Lease says the firm initially pitched its fund to UK pensions, thinking there would be strong appetite. It proved, instead, to be a fruitless period of struggling to educate people more familiar with real estate and fixed income (and perhaps, in some cases, not well advised by gatekeepers).

But here’s a safe prediction: eventually, the investor community will become more excited about the infrastructure opportunity in general and more attuned to the nuances of various infrastructure-related product offerings. At that point, they will look to the leading lights in the field for guidance and the ‘conventional’ closed-end fund managers may have even more competition for LP capital than they have today.