Perhaps fittingly for a long-term asset class, infrastructure is home to several long-running debates. For example, what comprises core-plus infrastructure? That’s not easy to answer, as the goalposts seem to be in perpetual motion.
Are renewables infrastructure? We simply don’t know yet, as there are not enough data on past performance, argues one source.
Will next year be the one in which the US finally embraces private capital to fix its crumbling infrastructure? Give us strength …
If there is one thing everyone has always agreed on, though, it is that they are investing for the long term in long-dated assets that will provide stable and reliable cashflows. That part of the infrastructure sales pitch is not in doubt. However, the ideal method to carry it out – a 10-year fund, a 25-year vehicle or an open-end one – is still a bone of contention.
The most popular fundraising route for infrastructure managers has been – and continues to be – the 10- to 12-year closed-end structure, a method made popular by the early infrastructure funds in the mid-2000s.
“If we’re going to ultimately unlock the public-private partnership market, I think permanence of capital will be a helpful facilitator of that process”
But as we enter the 2020s, there is reason to question whether the justification for going down this route is outdated. Specifically, are relatively short-term structures really the best way to maximise investments in long-dated assets?
There is no hesitancy in admitting that the use of shorter-term funds is, at least, partially a result of the era in which they grew up.
“When we raised our first [brownfield] fund in 2005, investors were already familiar with investing in private equity,” says Ed Clarke, co-founder of Infracapital, the infrastructure investment arm of insurance group M&G, which raised £908 million ($1.2 billion; €1 billion) for Infracapital Partners I at the time.
“We tried to make our fund structure as much like private equity as possible, in order to minimise any obstacles to prospective investors. This was about putting as few obstacles in front of investors as possible.”
The logic was a wide and prevailing one at the time, as managers sought to introduce a new asset class to groups of investors largely used to one way of thinking. Sean Klimczak, Blackstone’s global head of infrastructure, reinforces that point.
“It’s just easier to raise closed-end money,” he says. “You’re the new kid on the block. You’re already trying to do something new, which is raise a first-time fund. Do you also make it even more complex and introduce a different structure than people are used to? You probably don’t.”
However, as the industry was in its infancy, there was already some alternative thinking going on, with the core belief that infrastructure should be providing something different. Australia’s IFM Investors’ open-end Global Infrastructure Fund launched in 2004. Paris-based Meridiam Infrastructure began what would be a string of 25-year funds in 2007, in part following some encouragement from Canadian investors.
“There was a growing appetite for long-term assets for certain types of LPs,” explains Meridiam founder Thierry Déau. “One of the reasons Canadians became direct investors is because they couldn’t find long-term funds,” Déau adds that “at the time, people told me I was crazy”, but Meridiam went on to raise €547 million for its debut fund.
The manager now sits alongside other GPs – including compatriot Vauban Infrastructure, the UK’s Equitix and Irish renewables manager NTR – raising their flagship funds through 20- to 25-year structures.
Even this approach does the asset class a disservice, according to Andreas Köttering, head of European infrastructure at CBRE Global Investors, manager of an open-end mid-market fund.
“Why would you structure something where you’ve got a limited-life exposure to an asset class that is long-life or perpetual in nature?” he asks. “You know that limited term on the day you go in? That, to me, goes against the grain of what equity is all about.”
There’s certainly a human element as to why managers have tended to stick with the shorter-term fund structure, despite the increased knowledge of the asset class’s long-term benefits among institutional investors.
“This has typically been due to a preference around alignment [of interests] and team retention,” says Louisa Yeoman, a former co-head of distribution at AMP Capital and now founding partner of placement agent Astrid Advisors. “Namely, carry paid only on realised return and within a realistic timeframe, where the team [investors have] entrust[ed] the original commitment will still be in place.” Astrid’s other founder is Kate Campbell, who also co-headed distribution at AMP Capital.
“In our experience, longer tenure structures with performance fees on unrealised return have been more challenging for investors,” adds Yeoman.
Köttering agrees: “Where a closed-end structure helps is when calculating performance fees – it makes it objective. However, arm’s length procedures are well established for open-ended structures.”
From a manager’s perspective, it’s also about alignment between GPs and their portfolio companies. “That time horizon provides alignment between the fund and the portfolio company, giving appropriate time for us to drive changes and growth within the lifecycle of a long-term management team,” says Köttering.
However, questions about alignment get trickier once public stakeholders become involved.
In May 2017, for example, Macquarie’s European Infrastructure Fund 3, a 2008-vintage vehicle, announced it was beginning to explore a sale of its stake in Copenhagen Airport.
This was a matter of course for the fund, but not so for the Danish government, which reacted by looking to review the regulatory structure around the airport, stating it needed to “support long-term investments that will ensure continued development of the airport
Fittingly, the government was unable to specify what it envisaged as “long-term”, though it made no protest when local pension fund ATP bought the stake.
Similarly, our recent in-depth analysis of public-private partnerships found that one of the reasons the UK’s private finance initiative model fell out of favour was frustration among the authorities and the general public with concession owners selling assets midway through their life – and pocketing, according to some perceptions, outsized capital gains in the process. “If you’re talking to a city about a local airport public-private partnership,
I think it is imperative that you can commit to being their long-dated partner versus their transitory partner,” argues Klimczak. “If we’re going to ultimately unlock the public-private partnership market, I think permanence of capital will be a helpful facilitator of that process.”
“If you churn a business from one manager to another and then another, at each stage there is an entry and an exit cost. These costs are perhaps higher than people are prepared to admit”
CBRE Global Investors
“There’s always a suspicion from the public sector towards private sector involvement,” he says. “Our duration was a way to sell to them that we are aligning our interests with them – so long-term goals for the asset, rather than winning the bid and disappearing in five years when we get our money. ”As a 25-year fund manager, Meridiam may not be the permanent capital Klimczak is thinking of, but Déau expresses similar views.
Both believe it’s difficult to market infrastructure as a long-term asset class if the realisation period is never too far away. Clarke, however, offers a more nuanced picture of this situation.
“We’re seeing a lot more change in the digital and energy sectors which infrastructure companies are having to adapt to, and which I think better suits a shorter time horizon. If things settle down to a period of stability, we expect there would be more people looking to hold in longer-term structures.”
“Infrastructure means a lot of different things to a lot of different people,” says Brandon Donnenfeld, director and head of infrastructure strategies at KKR. “For KKR, a 12-year fund life, with the option to extend up to 15, fits well with how we deploy infrastructure capital and the types of long-dated assets we’re acquiring. Our funds’ structures – the investment periods, hold periods and overall fund lives – align with the deals we’re underwriting, which is what our LPs are looking for.”
Yeoman also believes different structures fit with different periods in an asset’s development: “While infrastructure assets have much longer operating lives, 10 years is an appropriate time to build a new asset or develop/grow an existing asset and release a return to the investor.
“As an asset enters a low-growth and more yield-generating profile, this is when it might shift directly to the investor, either through direct ownership or through a lower fee-profile/longer-dated fund.”
However, proponents of the open-end structure will readily argue that having to exit an asset simply because of fund life is counter-productive to growing businesses for the long-term, particularly when said businesses have become sector leaders.
For CBRE’s Köttering, costs are also an oft-ignored reality of trading in and out of funds: “I think people may have underestimated the costs you incur with closed-end structures. Entering a business as a shareholder and exiting always has costs. If you churn a business from one manager to another and then another, at each stage there is an entry and an exit cost.
“These costs are perhaps higher than people are prepared to admit. If you buy and sell on the stock market, the spread is very thin. The effort and the costs incurred in having M&A processes that allow one party to get all the advisers lined up, undertake due diligence and negotiate an exit and for another one to come in goes unnoticed. You wouldn’t necessarily have that in an open-ended structure.”
Winds of change?
Although the closed- versus open-end debate is well-trodden, there are indications LPs are becoming more open-minded.
Blackstone’s open-end fund now has a volume of about $14 billion, despite being less than three years in the market. Even when accounting for the significant presence of Saudi Arabia’s Public Investment Fund, this is a substantial raise and only rivalled by the likes of Global Infrastructure Partners and Brookfield Asset Management.
“The reality is if you churn [assets] every five to 10 years they’re not long-term and they’re not stable”
IFM’s Global Infrastructure Fund has now raised about $26 billion since inception. JPMorgan’s open-end Infrastructure Investments Fund currently has a deployment queue for investors of nine to 12 months, up from the regular three- to six-month period, as a result of increased demand, according to recent pension fund documents.
Furthermore, Macquarie Infrastructure and Real Assets, a traditional 12-year fund manager, launched in 2017 its 20-year Super Core Infrastructure Fund. It has raised €2.5 billion for the first series and more than €1 billion for the second, at the time of writing. “The market is more mature and so investors themselves became more sophisticated and are looking for more choice,” Leigh Harrison, head of MIRA in Europe, told us in June 2018.
Brookfield has also expanded from its closed-end structure to launch Brookfield Super Core Infrastructure Fund, an open-end fund that had raised $1.6 billion by August 2019. Bruce Flatt, chief executive of Brookfield Asset Management, said of the strategy at its launch in 2018 that there was a “big appetite for these types of products as a fixed-income alternative”.
“Infrastructure is an asset class that is growing, so people have more options than ever,” says Donnenfeld. “There’s more GPs than ever in the market and different investor types.”
“I found, in 2015, I was doing a lot of education and now the market is a bit more receptive and understanding that the shorter-term model has its own constraints,” adds Rosheen McGuckian, chief executive of NTR. The Irish renewables firm is now raising its second fund, following the launch of its first in 2015. “People are getting braver in moving away from private equity expectation.”
Our LP Perspectives 2020 survey illustrates this situation. Asked about infrastructure fund preferences for the first time, 41 percent of LPs said they prefer closed-end vehicles, with 20 percent favouring open-end ones. Thirty-nine percent, however, have no clear preference. That means managers will have to continue to adapt and suit the varying needs of an investor base that shows no let-up in its hunt for reliable cashflows.
Meridiam’s Déau has a final thought for those making up their minds: “The story behind the infrastructure asset class has always been you can access long-term and stable cashflows. The reality is if you churn [assets] every five to 10 years they’re not long-term and they’re not stable.
“Twenty-five years was as long as we could go at the time [of raising our first fund]. That respected the storytelling around the benefits of this specific asset class. You can’t gain those benefits if you’re selling it after eight years.”