Infra managers’ ongoing existential crisis

CalPERS’ decision to prioritise infra separate accounts serves as a reminder that LPs continue to question GPs on everything from investment structures to asset class benchmarks.

CalPERS, which is under-allocated to infrastructure but has an outperforming programme, has just disclosed that its preferred way of investing in the asset class going forward will be through separate accounts.

The why of it is not new (or surprising), with CalPERS citing better economic terms and governance as the main drivers behind its decision. It’s also important to put the California pension fund’s move in the context of its own high-profile admission this summer, alongside fellow pension CalSTRS, that it had difficulty tracking the amount it paid in manager expenses. But its decision matters because it again puts the spotlight on GPs’ ongoing existential crisis.

CalPERS, which only has 0.7 percent ($2.2 billion) of its $288 billion portfolio allocated to infrastructure, against a long-term target allocation of 2 percent ($5.76 billion), is telling fund managers that if they want a piece of that extra $3.76 billion, they’ll have to tailor their products to its needs. It’s also bluntly telling GPs that it’s not really that interested in their preferred product – the commingled, blind-pool fund.

Earlier this year, the pension decided to slash external fund managers from 212 to about 100 over the next five years, but deliberately excluded infrastructure fund managers from this cull. In fact, it wants to increase the number of infrastructure fund managers it employs from a current six to a target of 10. It just wants to do that on its own terms.

The tug of war over fees is certainly not new, as attested by the rise of LP direct investments, co-investment programmes, separate accounts, direct equity partnerships with developers, or tailored programmes with the likes of Townsend or Partners Group. But when an announcement like CalPERS’ comes along, it’s worth revisiting just how pressured GPs are nowadays on everything from investment structures to asset class benchmarks.

In one of the most interesting exchanges during our recent European fund management roundtable, Antin Infrastructure Partners chief executive Alain Rauscher complained that infrastructure assets are increasingly being packaged to offer a dividend to direct LP investors.

This is dangerous, Rauscher argued, because it makes LPs think of infrastructure in terms of a coupon – something that offers them a better dividend than treasuries during this historically low interest rate period – but makes LPs “have no policy in terms of internal rate of return (IRR) and yield […] decoupling the protection of value that comes from using IRR as a benchmark”.

Value creation, which IRR helps measure, is key for a GP’s ability to charge carried interest. The more ‘private equity-like’ an infrastructure GP is, the more value creation and carried interest matter. If the notion of infrastructure investing is decoupled from the notion of value creation, or the latter is minimised, it’s easy to see what’s at stake here.

It’s worth highlighting at this stage that there are plenty of infrastructure managers prepared to reinforce less traditional views on infrastructure investing. As we wrote in our December/January issue, some renewable fund managers are more than willing to devise inventive ways to help LPs book their equity funds through their fixed income quotas, wittingly or unwittingly strengthening the notion that infrastructure is nothing more than a bond-like investment.

It’s also worth noting that traditional GPs like Antin or EQT, through less orthodox investments in funeral homes, laboratories, cooking oil and laundry businesses, are also challenging the notion of what a typical infrastructure investment looks like.

In the end, there might not be a right or wrong way to invest in infrastructure. And it’s certainly healthy to have differing views vying for supremacy. The trend that will almost certainly not go away, though, is LPs’ forceful bid for more control over how they invest in this asset class.

That and commingled, blind-pool funds. While the pressures we described are real, you need only look at the $27 billion set to be collected next year by Global Infrastructure Partners and Brookfield for their third infrastructure funds to know the model is in rude health.