In the future, what will a well-designed infrastructure fund look like? And, as an investor, should you be interested in that fund anyway?
Even though infrastructure fundraising is at a low ebb at the moment (see chart), the debate surrounding funds will rumble on for months if not years. As part of your investment strategy, infrastructure is the talk of the allocating classes – but it is also shrouded in disagreement and confusion. It’s safe say that those bright minds see more than one road to a good place.
That a growing number of investors want infrastructure in their portfolios is possibly the only hard fact to rely on at the moment. The prospect of a perhaps relatively low, but steady and sustainable return has great allure. That it evidences pleasing counter-cyclicality too is not lost on most. But apart from these benefits, not much seems clear at all.
What exactly is infrastructure? How should institutional capital access it? What level of returns have different types of infrastructure assets in different segments of the class delivered in the past, and what if anything should those results suggest about performance expectations going forward?
The most burning issue of all, as far as institutions are concerned, is whether infrastructure investment management can be intermediated without reducing the net return to investors to a pittance. Investor views differ wildly on this point. Some have happily committed big money to private equity-style infrastructure funds with high management fees and generous carried interest provisions. Others are adamant that the private equity model is way too expensive to be applied in infrastructure.
To the naysayers, infrastructure funds that charge two and 20 (or anything close to it) are a rip-off: by the time the manager has been paid, the investor will have too little to show for himself. Recently an investment advisor with detailed knowledge of the asset class told Infrastructure Investor of a recent conversation he’d had with one of the largest, most savvy pension fund investors in America. This institution has a substantial appetite for alternatives and is a long-standing and loyal backer of one of the biggest names in private equity, which happens to be building a dedicated infrastructure platform to add to its franchise. “There is no way, absolutely no way, that the pension will support them in this, whatever the relationship on the private equity side,” was how the consultant described the investor’s attitude to the manager’s infrastructure project. No fence-sitting there, by the sound of it, and it was a deep scepticism about the transplanting of private equity compensation models that was at the root of the concern.
Fees cascading down
Of course, the private equity model is not the only point of debate when it comes to investing in infrastructure. Leveraged listed funds, like the ones first organised in the 1990s by Australian managers Macquarie and Babcock & Brown, are also on the back foot. Investors question the alignment of interest such funds provide, and the value for money they deliver.
The way forward is uncertain. In light of all the soul searching going on, it doesn’t surprise that some investors are thinking about investing in infrastructure directly. But while the merits of the DIY approach may seem obvious, so are the drawbacks. Anyone tempted to go it alone should take a hard look at one of the pioneers of direct infrastructure, such as the team at CPPIB in Toronto, and ask themselves: am I set up to do the same? Most funds are not, and direct infrastructure investment is arguably not for them therefore; outsourcing will be the better bet.
Partly for that reason, funds have a lasting role to play in infrastructure. Their managers are likely going to be compensated in increasingly complicated ways, with management fees starting low and cascading further down over the life of the fund, reduced hurdle rates, initial carried interest entitlements converting over time into stakes in the fund, and other such features. Eventually there will be an orthodoxy of infrastructure fund design. By the time it emerges a few things will be clearer: a much larger group of investors of varying size will be invested in the class, there will be a greater pool of specialist infrastructure managers – and fund formation lawyers will have made a fortune.