Carl Heiss, global head of investment at financial services company Towers Watson, said institutional investors should take a good look at the fee structures of infrastructure funds before deploying their capital in them.
“Investors should be very wary of the structure of some of these mandates with careful attention being paid to the ‘net of fees’ proposition, in particular for infrastructure,” he said. Heiss’ comments follow the release of a study, undertaken with the Financial Times, which found that pension funds were the largest investors in infrastructure during 2009.
The survey found that the top 50 infrastructure funds manage about $179 billion in assets for their respective investors with 60.6 percent of those assets, or $108.6 billion, being managed on behalf of pension funds. The report also found that the assets of the top 15 infrastructure managers increased by 43 percent from 2008 to 2009.
Heiss’ remark follows an earlier paper issued by Towers Watson, where the firm discusses how to improve fee structures for infrastructure funds. Echoing comments by many institutional investors, the paper argues that some of the fee structures imported by infrastructure funds from private equity are not appropriate to the asset class.
As such, it takes issue with infrastructure funds that charge fees on commitments, arguing they should rather charge a fee on invested capital. “In private equity […] a firm raising its first fund needed to have reliable income from day one to remain in business. However, in infrastructure, very few funds are raised by managers who are new to the business and the argument for steady income is less compelling,” the paper states.
High management fees are also a problem, according to Towers Watson, as “in many cases infrastructure managers view the management fee as a significant profit”. Robbert Coomans, adviser to the board of Dutch pension asset manager APG, the firm “would like to see management fees that reflect the actual costs of running the fund”.
One solution could be for infrastructure funds to charge a management fee during the investment period linked to the expenses incurred by the team and limited to no more than 1 percent per year for core infrastructure funds and 1.5 percent annually for higher-return infrastructure funds, the firm suggested.
Post the investment period, the fees would be “rebased to the acquisition cost of investments”, although they “should not be based on net asset value as this incentivises increased valuations,” it argued.
Regarding carried interest, Towers Watson believes “the majority of carried interest should go to the responsible team rather than the wider management firm”. This structure has been adopted by the European Union-focused €1.5 billion Marguerite fund.
In an interview published in the July/August issue of Infrastructure Investor, Nicolas Merigo, chief executive of Marguerite Adviser, the firm that runs the fund’s day-to-day activities, explained Marguerite’s approach to carry:
“Since the core sponsors are not involved in this business to make a profit out of the asset management part of it there’s no point in having profit on the management fee and all the carry goes to the investment team,” he said.
For PPP/PFI income infrastructure funds the carry should be based on the funds’ “net yield and should be above a benchmark that links the yield to inflation (for example, inflation plus 4-5 percent per annum),” Towers Watson argued, adding the carry “should be based on a three-year rolling cash-flow”.
Some fund managers have already adopted similar strategies, with the second Benelux infrastructure fund recently launched by Franco-Belgian team Dexia and GIMV paying annual cash distributions to investors linked to a long-term yield.
With respect to higher-return infrastructure funds, carry should be based on total return and should be placed in an escrow account. The management team would then be allowed to access a third of the carry every year but drawing funds from the escrow account would be contingent on the team’s ability to continue to meet the fund’s agreed total return target.
Catch-up, however, has no place in infrastructure funds, according to the report. “We believe that in infrastructure there should be no catch-up and that carried interest should only be payable on excess returns,” Towers Watson contended.