January, in most of the Western world, is when the year’s most attractive sales kick off. Yet this year the tradition seems to have all but eluded infrastructure markets: Swiss-based private markets firm Partners Group on Monday warned of “record” valuations in the “crowded” core segment; while 3i Infrastructure a few days later noted that stubbornly rising prices were causing an aggravating “compression of implied returns”.
That such stark observations now populate official statements further confirms, if such confirmation were needed, that the growing popularity of high-yielding infrastructure among global institutions is proving a mixed blessing for incumbent fund managers. True, these now have a much wider capital pool to tap when raising fund vehicles. But at a time when a number of core infrastructure assets find willing buyers at more than 25 times earnings, deploying money in a disciplined way is becoming ever harder.
Competition is unlikely to abate. Some of the world’s largest investors, in traditionally conservative markets such as Japan and Norway, are contemplating moves into core infrastructure; consolidation looms in mature ones such as Australia, where greater scale and resources could allow superannuation funds to get even more actively involved than they already are. Meanwhile trade players have plenty of money to spend.
There is a silver lining in this: the current environment is highly conducive to exits, allowing some fund managers to cash in on the inflationary climate. A relevant example is this month’s sale of UK rail leasing business Eversholt by 3i, Morgan Stanley, STAR and PGGM to Hong Kong-based Cheung Kong, for an overall tag price of £2.5 billion (€3.3 billion; $3.8 billion). Industry players expect more such deals in 2015. This could bring more assets to market and help the asset class further prove its worth, as vehicles raised in the pre-Crisis years demonstrate their ability to crystallise value.
But this development also raises two important questions. One is whether institutional investors, which by and large target infrastructure for its high-yielding, long-term characteristics, are happy to see their money come back after just a few years – even if there’s more of it. In the case of Eversholt and 3i, it seems they do have a reason to be happy: “A sale makes sense given the low implied discount rate at the sale price, and 3i now has even more firepower to invest in deals that are likely to produce a higher rate of return,” a JP Morgan analyst commented last week. But one may wonder whether every case will be as clear-cut.
A related question is what sort of returns investors will expect from now on, as the lucrative disposals of today may not accurately foretell what the asset class will deliver tomorrow. A consultative index recently launched by index provider MSCI found that 75 percent of the asset class’s annual performance globally can so far be explained by capital appreciation rather than recurrent income, itself largely the result of demand for core infrastructure outstripping supply. While the imbalance will continue to support high prices for some time, it is unlikely these will continue increasing at the same pace as they have over the last few years. Which in turns raises questions about what returns infrastructure will achieve once in its long-term steady state.
Whatever their answer to this, investors are already striving to anticipate developments. The largest limited partners are now seeking to enhance net returns by going direct or developing co-investment programmes, as has been well documented over the past couple of years. Smaller ones are teaming up to form joint platforms in a bid to gain capabilities and scale. Others are allocating more funds to managers in the mid-market – where price increases are more modest – or targeting assets that require more hands-on management. Few, so far, have been ready to concede on performance.
That puts large-cap fund managers in a bind. They have more and more capital to invest – a smaller player recently told us that some are now entrusted with “so many billions” that they are getting “desperate” to spend it all. Yet they’re finding it difficult to do so without compromising on their return targets, as 3i itself admitted this week. In this context, successful exits are short-term wins: redeploying the proceeds could well be the hardest bit. Whether it is their investment strategy or return objective, for the largest core infra players something may soon have to give.