No more head in the sand

A few weeks ago, this column reflected on the £392 million (€469 million; $631 million) that UK pension fund USS had parted with for a near-nine percent stake in Heathrow. This was a) a notably large cheque and b) a reminder that direct investors are not just competing for core infrastructure.

USS’ ambitions were further underlined when, earlier this week, it shelled out a further £143 million for almost 50 percent of The Airline Group, a major shareholder in the UK’s National Air Traffic Services (NATS).

At Infrastructure Investor’s recent European Fund Management Roundtable (see our December/January issue for a full account of proceedings), the subject cropped up again. “It’s interesting that direct investors have been buying stakes in airports,” mused Mathias Burghardt, head of infrastructure at Paris-based fund manager Ardian. “It’s clear that these guys won’t limit themselves to water companies.”

The words may not necessarily betray fear – Burghardt does not seem the type to be easily rattled and his own firm only recently completed a successful fundraising. But for others in the fund manager ranks, the march of the direct investors is an increasingly worrying theme. And it’s one they may have been guilty of under-estimating.

One infrastructure advisory professional recently confided to us: “In 2010, funds didn’t view directs [direct investors] as credible competition. They thought they wouldn’t get their act together. Now, it’s egg-on-face time.”

Some fund managers still hold to the line that direct investors still don’t have what it takes: their teams are too small, they lack experience, they don’t know how to look after their investments properly once they’ve acquired them. This may still be true of some, but it’s an increasingly tough argument to make.

For one thing, there are highly credible pension funds – such as the Canada Pension Plan Investment Board – that have been operating for some time, have built large teams and appear to have built a decent track record. But what alarms fund managers today is the resource being thrown at infrastructure by sovereign wealth funds (SWFs).

Last month, it was revealed that Kuwait Investment Authority had hired Hakim Drissi-Kaitouni from Bank of America Merrill Lynch to head up its new Wren House infrastructure investment arm. This followed other high-profile recent hires by SWFs: among them, former RREEF Infrastructure head John McCarthy to the Abu Dhabi Investment Authority (ADIA) and Morgan Stanley Asia’s ex senior managing director Deven Karnik to Qatar Investment Authority.

So what of the consequences? Larger funds will see more head-to-head competition for trophy assets. But even for the mid-market there is a knock-on effect as firms fleeing the larger end create crowding in the middle. Furthermore, as more organisations go directly into infrastructure, so the capital available for investment in funds diminishes – a trend entirely in keeping with the supposed reluctance of investors to bankroll material fees and carried interest.

This is not to imply too gloomy a future for the funds. Although “headline” fundraising numbers have been fairly static since the Crisis, this masks a proliferation of co-investment and managed accounts which some refer to as “shadow capital”. Plus, many of the leading funds with the best track records have – we are told – been able to hold a pretty firm line on the economics.

Moreover, funds appear to be striving hard to carve out niches for themselves in order to stand out from the crowd – including by partnering with corporates to tap proprietary deal flow and add operational skills.

Of course, this would not be quite as necessary were the direct investors justifying the low opinions that were widely expressed a few years back. The reality is that they’re proving uncomfortably tough opposition.