Let me have a go

As more institutional investors buy infrastructure assets directly, they will be hoping that their risk/return calculations pay off.

“Why get someone else to do a job that you can do cheaper (and maybe even better) yourself?” A question often posed by two disparate groups: do-it-yourself home improvement enthusiasts, and pension funds looking to invest in infrastructure. The recent purchase of a near-75 percent stake in German transmission firm Amprion from utility RWE by a consortium of mainly German insurance companies and pension funds was an example of two things: 1) the growth of institutional direct investment in infrastructure and 2) the adoption of the trend by institutional participants outside the Canadian and Australian markets. 

The usual caveat about institutions investing directly rather than through funds is that few have the experience and the resources to do it properly. Well, that’s as maybe – but let the observation be made, as it is being by market participants, that more of them seem willing to give it a try.

The supply of potential deals is increasing as strategics seek to free up capital from non-core infrastructure assets – perhaps to help repair balance sheets damaged by the global crisis or to invest in other parts of the business. And pension funds, frequently reminded that infrastructure represents a safe, steady and inflation-proof match for their long-term liabilities, are stepping up to the plate as buyers.

But as the investment bankers busily package up assets for sale, should potential buyers from the institutional investor ranks have any more to concern themselves with than a healthy suspicion of bankers? (if you are a banker, please consider this a light-hearted remark).

The institutions themselves may well say that they don’t apply much, if any, leverage to these assets and also that they have modest return aspirations. They are essentially low-risk, long-term investments. For that reason, they may even be prepared to stand behind what look suspiciously like lofty valuation multiples.

Infrastructure funds would much rather have these institutions investing in their funds and paying fees rather than providing stiff competition for new deals. With this important caveat in mind, these funds might choose to point out the following to such institutions: investing large amounts of equity may protect you from debt defaults, it doesn’t protect you from being highly exposed (over-exposed?) in the event of an investment going wrong; with direct investment, you have direct responsibility for operating performance that would otherwise be assumed by a fund manager; you have concentration risk – only by investing through funds will you get meaningful diversification; and your return targets are less than ours. Oh, and by the way, do you really understand regulatory and operational risk?  

Here’s another question: Will the burgeoning institutional direct investment theme survive the test of time? That may depend on whether ‘low risk’ investments are all they seem or whether, in some cases, the risk  profile is too good to be true.