Give us yield, collect your fees

When it comes to LP/GP fund agreements, the infrastructure asset class has been playing catch-up. Prior to the crisis, private equity terms and conditions were applied to infrastructure funds like an ill-fitting suit. Now that the idiosyncrasies of infrastructure investment are more widely recognised, more carefully tailored solutions are becoming available.

Take, for example, this week’s announcement that DG Infra+, a new fund being raised by Belgian bank Dexia and investment group GIMV, would incorporate a fee structure for the fund manager linked to the fund’s annual yield (from which cash distributions will be paid to investors).

This link between management fees/carried interest and yield has become a hot topic in infrastructure circles, and, therefore, the Dexia/GIMV fund is an interesting development.

At our annual Infrastructure Investor: Europe conference in Berlin earlier this year, Robbert Coomans, adviser to the board at Dutch pension APG, called for infrastructure fund managers to focus more on stable cash flows rather than internal rates of return since the former is key to inflation hedging, one of the main preoccupations of many infrastructure LPs.

Meanwhile, Henk Huizing, head of infrastructure investments at fellow Dutch pension PGGM, recently told Infrastructure Investor: “We have been discussing the possibility of paying a fee based on [an asset’s] annual yield with a hurdle of between five percent and seven percent. This would allow GPs to get paid on an annual basis instead of having to wait for a longer period of time.”

Huizing’s remarks are significant for two reasons. First, he makes the point that this kind of fee arrangement would benefit infrastructure GPs as much as LPs. The point at which carried interest kicks in varies according to the risk/reward profile of funds and mitigates against infrastructure’s lower risk/reward profile relative to private equity. This potentially presents an issue of lack of incentive, which shorter term payouts can overcome.

Second, PGGM has just announced a doubling of its direct investment resources. While direct pension investors often invest alongside fund managers and the relationship is thereby mutually beneficial, there is also an aspect to the growing direct investment trend that should worry GPs. Namely, pensions often cite what they see as unreasonable fund terms and conditions as one of the main reasons for seeking to cut out the middle man.

Funds such as DG Infra+ provide hints that, in an improving but still tricky fundraising market, GPs are listening harder to what investors really want.